National governments issue bonds primarily for fiscal reasons. Sovereign bonds denominated in local currency have different names such as US Treasuries, Japanese government bonds, gilts in the UK, and Bunds in Germany.
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 (between 10 and 30 years until maturity) are typical coupon-bearing 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 if there is a sudden increase in rates.
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).
Most sovereign debt having a maturity longer than one year are:
A. Floating-rate instruments
B. Zero-coupon instruments
C. Coupon-bearing instruments
The correct answer is C.
Most fixed income instruments issued by national governments having a maturity longer than one year are coupon-bearing instruments with stated periodic interest payments.
Reading 51 LOS 51e:
Describe securities issued by sovereign governments