What are the advantages and disadvantages of sovereign bonds?

Answer 1

Sovereign bonds are bonds issued by national government. The advantages and disadvantages of sovereign bonds are stated as follows:

Concerning the advantages:

- In terms of the investors:

+ Firstly, one of the advantages of sovereign bonds is their very low risk. In many case, they are called risk- free bonds. Therefore, these bonds are suitable for investors who fear the volatility of certain investments and prefer a safe place to invest or in a market with instabilities.

+ Secondly, sovereign bonds are liquid. The truth is that they are bought and sold on the open market every day.

+ Thirdly, the tax benefit enjoyed by the investors is also an advantage of sovereign bonds. In fact, all income from them is taxable at the federal level, but not taxable at the state and local level.

+ Lastly, because sovereign bonds can often perform well even when other asset classes cannot, they may be a good diversifier for investors.

- In terms of the government:

+ By issuing bonds, government can have a new cash flow to spend to obtain some certain objectives. Moreover, they can also resolve the current situation of budget deficit.

Regarding the disadvantages:

- In terms of the investors:

+ Firstly, the interest paid on sovereign bonds is low. It can be explained by the low risk of them.

+ Secondly, if interest rate or inflation increases, the value of the bonds can reduce because of the fixed interest paid by bonds ( except for the case of TIPS which has the outstanding principal is adjusted for inflation)

+ Lastly, sovereign bonds can be vulnerable in the case that the government issuing them now suffer a fiscal crisis, that makes people are unsure about whether debt obligations will be honored.

- In terms of the government:

+ Because after issuing bonds, government have more money, which can lead to the fact that they will spend too much, even more than the necessary amount that should be spent. Moreover, when they issue too many bonds, they may suffer debt insolvency