A government bond is a debt security issued by a sovereign State. For an individual who lives in a eurozone country, European bonds are probably the safest form of investment. In the eurozone, Italy, France, Germany and Spain are the largest issuer of government bonds and account for 80% of all issues in the 19 countries of the zone.
What is a government bond?
A government bond is a debt issued by a sovereign State. State bonds, sovereign bonds or government bonds are synonymous.
A State faces various expenses. To finance its expenses, it generally collects taxes but can also benefit from its people savings by issuing government bonds. Concretely, the State borrows a certain amount for a fixed period. Over that term, it pays out a predefined interest periodically, before paying back the borrowed amount at maturity.
A concrete example
Imagine that Belgium wants to build a new highway. To pay the workers, engineers and equipment, it decides to raise funds via a bond issue.
To do this, it offers you to buy a bond worth 1.000€ and offers you an interest rate of 4% per year for a period of 5 years.
Concretely, you are handing out 1.000€ to the Belgian State today. The State then pays you 40€ (i.e. 1.000€ x 4% = 40€) at the end of each year for 5 years. It will finally reimburse your 1.000€ at the end of the fifth year. At the end of the day, you will have realized a return on investment of 4% per year without taking much risk.
The "risk-free" asset
In the academic literature, the government bond is often defined as the "risk-free" asset. This name comes from the fact that the government bond is considered a safe investment to the extent that a State can at any time increase its taxes or issue money to honour its debts.
Nevertheless, not all countries are born equal when it comes to the notion of “risk-free”. If government bonds issued by countries such as Germany or the United States have a default risk close to zero, this is not the case for countries such as Greece, Congo, and Argentina.
The eurozone government bond market
The above infographic shows what the government bond market looks like among the 19 countries forming the eurozone. It represents each country in proportion to the total volume of outstanding bonds.
The European Central Bank reports that at the end of 2015, the value of outstanding government bonds totalled to 6.700 billion euros, of which 80% came from Italy, France, Germany and Spain.
Belgium is the fifth largest issuer in the euro area with 5% of all outstanding government bonds, i.e. 350 billion euros.