Government bonds explained: How they work and how to buy them

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When the share market took a hit at the start of the COVID-19 pandemic, it was no surprise to find people looking around for alternatives.

One of the alternatives that has been increasingly popular is government bonds.

Australian government bonds raise money for the government to fund projects and in return offer a guaranteed rate of interest and, after an agreed period, your loan will be paid in full.

According to the Australian Security and Investment Commission’s MoneySmart website, Australian government bonds are the safest type of bonds. This is because if you buy and hold them to maturity you are guaranteed a rate of return.

When you invest in bonds you are lending money to the government. In return, you get regular interest payments, called coupon payments. If you hold the bond until maturity, you get back the face value of the bond.

The face value of a bond is the set value of the bond when it was first issued and is how much you pay for the bond and is also the amount you get back if you hold a bond until maturity.

Why choose bonds?
The coupon payments at regular intervals can provide a stable and predictable income stream and the interest rates that you can earn can be higher than a savings account or term deposit.

Government bonds also have high liquidity, which means they are easy to sell if you need to free up money quickly.

Government bonds are also lower risk than growth investments such as shares or property.

How to buy them
You can buy or sell exchange-traded Australian government bonds (AGBs) at market value in the same way that you buy or sell ASX-listed shares.

The market value may be higher or lower than the face value and you will also have to pay any brokerage fees.

Interest on bonds
The interest on a government bond can be paid at a fixed rate, a floating rate or an indexed rate.

The fixed rate means that the interest rate is set when the bond is issued and it stays the same until maturity.

The floating rate means that the interest rate can go up or down over the term of the bond, in line with the cash rate determined by the Reserve Bank of Australia (for example the floating rate may be set at the cash rate + 2 per cent).

The indexed rate is for those looking to protect against rising inflation. Both the coupon payment and the face value of the bonds increase in line with the consumer price index (CPI).

Selling a bond before maturity
If you buy a bond and hold it to maturity, you’ll get back the face value. But if you sell a bond before maturity, you’ll get market value. This can be more or less than the face value.

The market value of a bond usually depends on market interest rates. That is, the price of fixed rate and indexed bonds moves in the opposite direction to market interest rates. If the market interest rates rise, the price of these bonds falls. If market interest rates fall, the price of government bonds rises.

As with any financial product, you should consider if it is right for your circumstances and seek independent financial advice. 

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Written by Ben

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