Securities Issued by Sovereign Governments

National governments issue bonds primarily for fiscal reasons. As a result, sovereign bonds denominated in local currency have different names such as US Treasuries, Japanese government bonds, gilts in the UK, and Bunds in Germany.

Treasury Securities

US government bonds that mature in less than 1 year are called T-bills. T-bills are pure discount (zero-coupon) bonds as they are issued at a discount to par. In contrast, capital market bonds such as T-notes (maturity of one to 10 years) and T-bonds (10 to 30-year maturity) are typical coupon-bearing bonds.

Sovereign Bonds

Sovereign bonds are issued by a country’s central government and are usually unsecured obligations as they are not secured by collateral. However, a high credit rating is still possible for sovereign bonds denominated in local currency. These securities can either be fixed-rate bonds (pure discount, no interest) or coupon-paying bonds (periodic interest plus principal payment at maturity). Fixed-rate bonds are exposed to more interest rate risk than coupon-paying bonds because investors cannot reinvest the coupon payments at a higher interest rate in case of a sudden increase in rates.

The majority of trading in secondary markets is of sovereign bonds that were most recently issued. The most recently issued and most actively traded sovereign securities are referred to as on-the-run. Generally, as sovereign issues age, they tend to trade less frequently.

Floating Rate Bonds

Floating-rate bonds reset interest rates periodically based on a reference rate such as the LIBOR. Thus, interest rate risk is minimized. Many national governments also issue inflation-linked bonds – also called linkers – whose cash flows are adjusted for inflation. Examples of such bonds are the  Treasury Inflation-Protected Securities (TIPS), whose cash flows are based on the consumer price index (CPI).

Question

Most sovereign debts that have a maturity longer than one year are:

1. Floating-rate instruments.
2. Zero-coupon instruments.
3. Coupon-bearing instruments.

Solution

The correct answer is C.

Most fixed income instruments issued by national governments and have a maturity longer than one year are coupon-bearing instruments with stated periodic interest payments.