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    What is 'Sovereign Bond'


    Definition: A sovereign bond is a specific debt instrument issued by the government. They can be denominated in both foreign and domestic currency. Just like other bonds, these also promise to pay the buyer a certain amount of interest for a stipulated number of years and repay the face value on maturity. They also have a rating associated with them which essentially speaks of their credit worthiness.

    Description: To meet their expenditure, governments have 2 options: either to raise taxes or to issue bonds. Raising taxes is an unpopular move which has a lengthy legal process. So, Sovereign bonds are preferred as they are similar to taking loans from the market.

    The Yield of the sovereign bond is the interest rate that the government pays on issuing bonds. Countries with volatile economies and high inflation rates have to issue higher interest returns on their bonds compared to more stable ones.

    The Yield of the bonds are dependent on primarily 3 factors

    • Creditworthiness - The issuing countries’ perceived ability to repay their debts. This can be obtained from rating agencies.

    • Country Risk - External/Internal factors like unrest and wars tend to jeopardize a country’s ability to pay off their debts.

    • Exchange Rates- In cases where bonds are issued in foreign currency, fluctuations in exchange rate may lead to increased pay out pressure on the issuing government.

    The central banks also control the supply of money within the economy by the use of these bonds. When the government is in expansionist mode, the central bank will back debt in exchange for cash to raise capital for the expenditure. In case it is in the contracting mode, the banks hope to slow growth by selling more securities to take out liquidity from the system.
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    The Economic Times