No 227: Bonds - the basics

 FOR those of you just starting Economics, or those who just need a recap, here are some basics about government bonds.

Often, especially during crises, government spending is greater than the tax revenue it is receiving. In such a case, it needs to borrow money. It cannot just go to a bank to get a loan like ordinary people do. Instead, it announces to the bond market that it needs to borrow, and issues bonds at an interest rate high enough to attract investors.

A bond is a piece of paper that works like a receipt (or used to be, they are electronic now).

Any bond contains the following information: 

• How much money the bond is worth (i.e. how much is being lent to the government).
• When this money will be paid back to the lender by the government.
• In the time before this, how much interest the lender will receive per year from the government.

This diagram shows how this works with a 10 year UK bond, if its yield were 5% :

 

As you can read in previous posts, the current problem with bonds in the UK is that markets are worried by the recent government plans for tax cuts and for keeping energy bills low. Investors are concerned how/if these policies will be paid for,  so they have more doubts about buying UK government bonds (i.e. doubts about lending their money to the UK government). Therefore, they are asking for a higher interest rate in order to buy them - the 10 year bond rate was around 1% in January, and rose to 5% before the recent Bank of England action (see previous post).