What are government bonds and how do they work?

Knowing your options as an investor is vital in achieving a well-balanced portfolio. You may already know what bonds are, and that there are corporate bonds and government bonds. If you’re interested in stable, low-risk investments, keep reading to learn more about what are government bonds, how they work, and how to invest in them.

What are government bonds?

Government bonds are debt securities issued by national governments or government agencies. These are a type of fixed-income investment that are considered low risk because they are backed by a government’s ability to tax.

Government bonds are used to raise funds for various projects, such as infrastructure, public schools, hospitals, and so on. In exchange for lending money to the government, bondholders receive interest payments on a semi-annual or annual basis.

How do government bonds work?

Before we discuss how bonds work, we need to establish the Key features of government bonds:

• Issue price: The bond’s price upon purchase.
• Face value: The bond’s value upon maturity.
• Maturity: The period from the issuance of the bond until it expires, and the government must repay the bondholder.
• Coupon rate: The interest rate that the issuer agrees to pay the bondholder. This is computed as a percentage of the bond’s face value.
• Coupon payment: The periodic payments from the issuer to the bondholder. This can be done semi-annually, quarterly, or annually.
• Yield: The bond’s effective returns upon maturity.

When you buy a government bond, you are essentially lending money to the government. The government uses the money to fund various projects and, in exchange, pays you back the principal amount plus interest. Depending on the type of bond, payments may be given periodically or upon maturity.

Government bonds are fixed-income investments, which means that the interest rate and coupon payments don’t change throughout the term.

Upon the bond’s maturity, the government returns the principal and interest. However, the bondholder also has an option to liquidate their bond by selling it on the secondary market.

Three types of government bonds

Different types of government bonds have unique features that affect the ROI they offer. Here are the three government bonds and how they work:

• Treasury bills (T-bills): Short-term debt security with maturity rates of up to one year. Instead of coupon payments, bondholders get returns in advance since they buy the bonds at a discounted price to the face value.
• Treasury Bonds (T-bonds): Short-term debt security issued by the Philippine government with a maturity rate of three years. Investors receive a fixed coupon payment every quarter and then receive the principal and interest upon maturity.
• Treasury Notes (T-notes): Medium- to long-term debt security issued by the national government with maturity periods ranging from 3 to 25 years.

For example, a government bond in the form of a T-bond worth PHP 500,000 with a three-year tenor and a 2.375% annual interest rate, will generate PHP 2,968.50 coupon payment every quarter for the next three years.

Meanwhile, a T-bill worth the same, with a one-year term and a 2.375% annual interest rate, will not generate payments. However, the investor will likely purchase the bond at around PHP 460,000.

How to buy government bonds

Government bonds are issued by the national government through the Bureau of the Treasury (BTr) but are bought and sold through primary markets – through banks like Metrobank – or in the secondary market where it is traded among fellow investors through brokers.

Most government bonds have a minimum investment requirement of PHP 500,000.

The government issues bonds through an auction where investors submit bids specifying the amount they are willing to invest and the corresponding returns they seek. The higher bids receive priority.

The interest rate or coupon rate, as well as the payment date, is determined upon the bond’s issuance. These terms remain fixed until the maturity of the bond.

Throughout the bond’s term, the bondholder receives the coupon payments on the specified dates. At maturity, the government returns to the investor the bond’s face value for T-bills and the principal and interest for T-bonds and T-notes.

Investors may choose to trade their government bonds in the secondary market. Bond prices in the secondary market fluctuate based on changes in interest rates, market conditions, and investor demand.

Risks associated with government bonds

The best way to learn how to invest in government bonds is to understand the factors that affect its price and value:

Interest rates – higher interest rates make other investments more attractive. Hence, the demand for bonds reduces and, with that, its price.

Inflation rates – the purchasing power of the fixed interest rates decreases when inflation rises, making bonds less valuable.

Supply and demand – low demand for bonds, such as when interest rates increase, results in low government bond prices, especially in the secondary market.

Is it a good idea to invest in government bonds?

As low-risk investments, government bonds offer stability and a regular stream of income, especially when interest rates are low.

Government bonds are a great inclusion for those who want to diversify their investment portfolio. The security of government bonds can balance out the risk carried by other high-yield investments.

This type of bond can also be a wise choice for new investors who are not yet ready to take on more risk. This investment enables them to grow their capital with minimal risk.

Ready to invest in government bonds?

Are you investing in Metrobank Peso Retail Treasury Bonds or do you prefer T-bills or T-notes? Understanding how government bonds work is the first step to making smart investment decisions that can lead you to financial freedom.

Be sure you’re well-informed of your options before you start investing. Get in touch with us to get more exclusive investment tips.