Why Are Government Bonds Important

Government bonds can be described as a debt security issued by a government to sustain government expenses. Government debt is money owed by any level of government and is financed by the full faith of the government. The terms on which a government can sell bonds depend on how creditworthy the market considers it to be. Government bonds are seen as a good way of preserving capital while generating a reticent return every year. Most governments around the world rely on the issuing of new bonds to cover their deficit spending. The risk-free rate is the yield on high quality government bonds. For most investor, the US Treasury yield is the risk-free yardstick that is not in favor of which other assets can be measured. Many government bond issues are “safe” and have a low chance of default compared to corporate bonds, but there is still some risk in investing in government bonds as before investing in government bonds, investors need to

The same thought does not automatically apply to a foreign holder of a government bond, since the foreign holder also needs compensation for potential foreign exchange movements in addition to the compensation required by a domestic holder. Since the risk free rate should hypothetically eliminate any risk, default or otherwise, this denotes that the yields on foreign owned government debt cannot be used as the basis for calculating the risk free rate. Since the required return on government bonds for domestic and foreign holders cannot be distinguished in an international market for government debt, this may mean that yields on government debt are not a good proxy for the risk free