What a government bond is, and why anyone buys one

A government that spends more than it collects borrows the difference, and one of the ways it borrows is by issuing bonds. A bond is a loan with its terms fixed in advance: an amount, a date it is repaid, and the interest paid along the way.

You lendYear 1Year 2Year 3Money back

A loan with a diary: a coupon each year, then the money back at the end.

Buy one and you are the lender. You hand over the amount, receive the interest on its stated dates, and receive the original amount back on the date written on it.

That is the appeal. Next to owning part of a company, where nothing at all is promised, a bond states what it will pay and when. The range of outcomes is narrow, as long as the borrower pays.

Whether the borrower pays is the first risk. Governments are generally treated as more reliable borrowers than companies, which is why they usually pay less interest, and some governments are treated as far more reliable than others. The interest offered is the market’s opinion of that.

A bond states what it will pay and when. The rest is whether that stays worth having.

The second risk is the one that seems strange at first. A bond can be sold before its repayment date, and what somebody will pay for it moves in the opposite direction to interest rates. When new bonds start paying more, an older bond paying less is worth less to a buyer. Held to the end, the stated terms still apply. Sold early, the price is whatever the day offers.

The third is inflation. A bond that pays a fixed amount pays the same figure whatever prices do, so if prices rise faster than the interest, the money that comes back buys less than the money that went in.

How bonds are bought, what they are called and how they are taxed differs completely from one country to the next, and none of that is covered here. What travels is the shape: a fixed loan, a stated return, and three things that can still change what it is worth.