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Government Bonds and Treasury bills: everything covered

What is fixed income? The so-calledĀ fixed incomeĀ - Treasury bills, government bonds, obligationsĀ ... - areĀ debt instruments issued by a state or priv

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What is fixed income?

The so-calledĀ fixed incomeĀ – Treasury bills, government bonds, obligationsĀ … – areĀ debt instruments issued by a state or private company,Ā homogenized with the same value that allows them to be exchanged between investors.

Difference between government bonds and Treasury bills

One of the main differences is the term of the issue:

Treasure letters

They are for emissions of less than 18 monthsĀ .Ā The discount formula is used by which we buy a nominal, minus theĀ interest rateĀ applicable to the operation, andĀ the total nominal amountĀ is returned to us atĀ maturityĀ .

Government bonds and obligations

They are for issues over 18 months.Ā Ā TheĀ paymentĀ of coupons is used, where at the initial moment we pay the nominal or aĀ percentageĀ on it and we are paid coupons (quarterly, semi-annual or annual) of the% on the nominal being, on the expiration date of theĀ productĀ , when the nominal plus the lastĀ correspondingĀ couponĀ is returnedĀ .

What are government bonds?

Among all these instruments,Ā the governmentĀ bondĀ is aĀ long-term securityĀ .Ā Government bonds and obligations are issued by the Government toĀ financeĀ theĀ public deficitĀ .

Difference between government bonds and obligations

The only difference between a bond and anĀ obligationĀ is theirĀ repaymentĀ termĀ :

  • Government bonds and obligations are issued and “promise” aĀ fixedĀ returnĀ that is paid in annual payments.
  • Securities issued at a value (Ā nominal valueĀ ) pay a specified explicit interest on theĀ investmentĀ .Ā That is, a 3% bond will periodically pay the equivalent of 3% of the initial investment.
  • Issues are made throughĀ competitiveĀ auctionĀ and by tranches toĀ ensureĀ high liquidity.
  • Treasury bills areĀ short-termĀ .
  • The bonds are issued for 3 and 5 years.
  • The bonds are issued for 10, 15 and 30 years.
  • They are issued in nominal amounts of ā‚¬ 1,000 or multiples of this amount.

Where are government bonds and obligations traded?

These products are thenĀ listed on the market during their life span in order to offer the investor theĀ optionĀ to sell or buy them before reaching their endĀ , which will be when they return all theĀ investedĀ capitalĀ to the investor.Ā Thus,Ā Ā the real price of the security may be above, below or at par with the nominal value during its life (1,000 euros per security), this may depend on:

  • The proximity or remoteness of the coupon payment (interest on the nominal amount).
  • The interest of the secondary market at the time of purchase
  • Health of theĀ economyĀ of the country or of the issuing company.

What is the profitability of government bonds?

The profitability is predetermined throughout the life of the government bondĀ (coupon) so that if it is maintained until its maturity, the investor will know exactly how much and when it will be obtained, as long as theĀ issuingĀ company or bodyĀ complies with the payments.

Currently there are other more sophisticated types of bonds, with variable interest linked to certain indicators, such as interest rates (Euribor, etc.), stock indices, or even the evolution of a certainĀ shareĀ , index, etc.Ā What makes the profitability of these specific products is no longer defined from the beginning.

TheĀ profitability is related to the credit quality ā€“capacity to pay the debtā€“ of the issuer,Ā so the worse the creditĀ ratingĀ (Ā ratingĀ ), the greater theĀ riskĀ and therefore the higher the profitability offered will have to be for an investor to be interested .

How do interest rates affect government bonds?

What most affects the performance of fixed income is the evolution of interest ratesĀ .Ā The investor who wants to sell a fixed income security before its repayment date runs an interest rate risk.Ā This risk will be greater, the longer the term of repayment of the title.Ā In other words, if interest rates rise, new issues of fixed income in theĀ primary market willĀ have to increase their emission rates and changes in the market for fixed income already issued will fall.

InĀ Finance for EveryoneĀ they explain it in a very simple way: an investor buys aĀ newly issuedĀ bondĀ with a 6% coupon, which means that it generates ā‚¬ 60 per year in interest for every ā‚¬ 1,000 of nominal value.Ā But within a year interest rates go up.Ā Your bond will continue to offer only ā‚¬ 60 per year, but new issuers will now offer higher returns in line with the new rates (eg 7%).Ā As investors now have the opportunity to buy new bonds, like the one you have but that offer a 7% return, the only option that the inverse has to sell yours at 6% will be to sell it below its nominal value (that is, say, discounted).

In the same way, if interest rates fall, the new bond issues will offer returns below 6%.Ā This will make your bond more attractive to other investors, and they will be willing to pay you a price for yours above its face value.

To reduce the risk of interest rate or repayment risk, it is important to contract securities with repayment terms in line with your financial objectives.

InflationĀ expectationsĀ :Ā the coupons that pay the fixed income are nominal over time and if inflation rises, the real value of the coupon falls and the profitability of that fixed income is lower.

How to buy a government bond?Ā 

The purchase of a governmentĀ bondĀ , or what is the same, the subscription ofĀ public debtĀ can be carried out through several channels:

  1. A governmentĀ bondĀ can be purchased at anyĀ Banco de EspaƱa office
  2. A governmentĀ bondĀ can also be purchased through theĀ Public Treasury websiteĀ , under the option: “securities purchase and sale service”
  3. In financial entities (banks or savings banks) and in securities companies and agencies.Ā This option is the simplest because it guarantees you greater peace of mind.Ā Through theĀ Bankinter broker, you can contract a wide range of public and private debt issuesĀ , both national and foreign, with the greatest reliability.

What are treasury bills?

The letters of the Treasury fixed income securities are short –Ā term represented exclusively by book entryĀ accountĀ .Ā The Bills are issued with a minimum amount of 1,000 euros, with higher requests having to be multiples of 1,000 euros.

How is the profitability of the Treasury bills?

Treasury bills are issued for a lower amount than will be received at the time of redemption.Ā The return will be the difference between the redemptionĀ priceĀ and yourĀ purchase priceĀ .

Currently the Treasury issues Treasury Bills with the following terms:

  • 3-month Treasury bills
  • 6-month Treasury bills
  • 9-month Treasury bills
  • 12-month Treasury bills

Glossary of basic terms for public debt instruments

  • Primary market: itĀ Ā is the market generated at the time of issuance of the asset, when it is offered to investors for the first time.
  • Secondary market:Ā Ā in this market securities that have previously been issued are traded.Ā We must bear in mind that investing in fixed income does not mean that our investment must have a duration equal to the life of the asset, but that through this market we can undo (sell) or make an investment (buy) in this type of assets at any time.
  • PrincipalĀ :Ā Ā is the reference value of a bond.
  • ExplicitĀ Ā yieldĀ : itĀ is the yield of a bond that is received through periodic payments (coupons).
  • ImpliedĀ Ā yieldĀ : itĀ is the yield obtained by the difference in prices at the time of issuance of the asset and its nominal orĀ amortization priceĀ .
  • Amortization: itĀ Ā is the return to theĀ holderĀ of a certain fixed income security of the invested funds, that is, the nominal value of the security.
  • Nominal value: itĀ Ā is the theoretical value that is established as a unit price within a certain issue, it does not have to coincide with the acquisition price of the asset or with the amortization price.Ā It is used for the calculation of coupons, if you have them.
  • Maturity:Ā Ā amortization date fixed for a certain asset.