Investor's wiki

Sovereign Bond

Sovereign Bond

What Is a Sovereign Bond?

A sovereign bond is a debt security issued by a national government to fund-raise for financing government programs, paying down old debt, paying interest on current debt, and some other government spending needs. Sovereign bonds can be designated in a foreign currency or the government's domestic currency. Sovereign bonds are a source of government financing alongside tax revenue.

Figuring out a Sovereign Bond

Like any bond, sovereign debt qualifies owners for periodic interest payments from the issuer โ€” in this case the government โ€” as well concerning the repayment of the bond's face value when its term matures.

Likewise with different bonds, the interest rate paid, or yield, relies upon the risk profile of the issuer. For a sovereign bond, the yield will be higher for countries seen at higher risk of a default. Investors consider the economic profile of the country, its exchange rate, and politics to estimate the probability of a default on sovereign debt obligations.

Rating agencies including Standard and Poor's, Moody's, and Fitch Ratings give sovereign credit ratings to investors seeking to comprehend the risks implied in investing in a specific country. These agencies likewise give credit ratings on corporations and corporate debt securities.

Sovereign Bond Denominations

A few non-industrial nations can't draw in foreign investment in that frame of mind in their domestic currency in light of the fact that foreign investors are reluctant to expect the exchange rate risk. Their currency markets may not be adequately liquid, or investors may not completely accept that the currency will keep up with its value due to inflation, eroding their rate of return.

Countries borrowing in a foreign currency face comparative currency exchange risk, and higher borrowing costs assuming the domestic currency loses value against that in which the sovereign bond is named.

For instance, say the Indonesian government issues bonds named in yen to raise capital. It consents to a nominal annual interest rate of 5% however all through the bonds' term the Indonesian rupiah deteriorates by 10% annually versus the yen. Accordingly, the real interest rate on the yen-designated debt to the Indonesian government is 15% in rupiah terms.

Investing in Sovereign Bonds

Investing in U.S. sovereign bonds is genuinely direct and should be possible on TreasuryDirect.gov. Buying foreign bonds is a bit more precarious and is normally done by means of a broker through an account set up for foreign trading. The broker would regularly buy the bond at the predominant market price. This route can be restricting, contingent upon what bonds are accessible, and transaction costs could be high.

A simpler alternative is to buy U.S. mutual funds or exchange-traded funds (ETFs) that hold foreign sovereign bonds. These funds likewise give diversification with exposure to an assortment of foreign bond issues, which might relieve investment risk.

Famous foreign sovereign bond ETFs include:

  • iShares International Treasury Bond ETF (IGOV)
  • SPDR Bloomberg International Treasury Bond ETF (BWX)
  • SPDR Bloomberg Capital Short Term International Treasury Bond ETF (BWZ)
  • Franklin Liberty International Aggregate Bond ETF (FLIA)

Highlights

  • Sovereign bonds can be issued in the government's domestic currency or in a foreign currency.
  • Riskier sovereign borrowers โ€” those with a creating economy or higher political risk โ€” will generally designate sovereign bonds in the currencies of additional stable economies.
  • Sovereign bonds are debt securities issued by a government to raise capital for spending needs, for example, on government programs and paying down debt.
  • Foreign government bond exchange-traded funds (ETFs) offer a simple method for investing in the sovereign bonds of foreign issuers.