Sovereign bond

From Academic Kids

A sovereign bond is a bond issued by a national government as opposed to a municipal bond which is issued by a subdivision of a national government and as opposed to a corporate bond which is issued by a corporation.

Sovereign bonds when denominated in the country's own currency are usually considered risk free when the risk is measured in the issuing currency. This is because the nation concerned can raise taxes or simply print more money to repurchase the bond when it is due. E.g. United States treasury bonds are denominated in US dollars and they are considered the safest US dollar investment known but most foreign investors in these bonds would have been disappointed in 2004 because the value of the dollar declined against most other currencies. If high inflation is thought likely governments also have difficulty in issuing bonds as, at the time of repayment, the amount invested will be worth much less. The UK and many other nations also issue inflation indexed bonds to cope with this confidence problem.

Nations with very high or unpredictable inflation or with unstable exchange rates often find it uneconomic to issue bonds in their own currencies and so are forced to issue bonds denominated in more stable foreign currencies. This raises the issue of default if the nation cannot afford to repurchase the necessary foreign currency at bond repayment time. The risk of default means that investors require the bonds to be issued paying a higher yield and this, making the debt more expensive to service, makes the risk of default higher! In the event of default, unlike a corporation or even a municipal subdivision, a nation cannot file for bankruptcy. But on the rare occasions that a default occurs, just as in defaults on corporate bonds, recent practice has been that the defaulting borrower presents an exchange offer to its bond holders in an effort to restructure the sovereign debt, as has been the case in US dollar denominated bonds issued by Peru (1996) and Argentina (2001). However, getting the bond holders to accept an exchange offer has become very difficult, something caused by the holdout problem.

During the early 1980s, the sovereign bonds of developing nations were a popular investment for Western banks. These created many problems when some nations found it difficult to repay those bonds.

Bonds issued by the UK national government are called gilts.

External links

See also

de:Staatsanleihe nl:Staatsobligatie

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