eli5 What are government bonds and how do they work?


Additionally why are they considered safer than stocks.

In: 6

They are loans given to the government. They pay out a flat interest, and the loan contract is basically resold to other people.

They are pretty much guaranteed to stay valuable except for the rare case that the government that gave them out goes bankrupt.

When the government needs to borrow money, for example if they want to build a bridge to improve the economy so they can collect more taxes, they can not just go to a bank and take out a loan. No bank in the world have enough cash on hand to bankroll a government. So instead what the government is doing is to split up the big loan into many smaller loans and then invite every banker and investor to place bids on these loans in a large auction. These are called government bonds. But if you buy a bond at an auction that does not mean that you need to keep on to that until it is due, you can sell it to anyone else who wants to take over the loan for you. So in addition to the regular government auctions of new bonds there are continuous private markets where the bonds are being sold and bought all the time.

Comparing it to stocks they are much safer. If a company goes bankrupt then the stocks are worthless. And companies go bankrupt all the time. However countries generally do not go bankrupt. Even when countries do go bankrupt they usually end up paying the bonds eventually anyway. Most of the government bonds are owned by their own population, primarily middle class citizens own bonds indirectly through bank deposits, insurance, union savings, pensions, collage funds, etc. So it is extremely rare to lose money on government bonds. And if you do then you usually have much bigger issues to worry about then your savings.

You give the government $10 right now for some project they’re working on or want to work on and they hand you back a document that says they’re going to pay you back $12 five years from now. You essentially loaned them $10 and will collect 20% interest on that loan.

They’re safer than stocks because governments in developed countries don’t tend to disappear or run out of money. If I buy $10 worth of stock in a company and that company fails, my shares are now worthless and there’s no one left to pay me back. But the government of my country is always going to be there and always have money to pay back the loan.

While they are safer and pretty much guaranteed returns, it takes longer to get your money back and bonds also have much smaller potential profit. A stock can jump in value 10 or 20x in a very short time frame (such as GME) but it’s also way riskier.

Government out of cash, dont want to print more, get cash from people for offering a piece of paper (the bond) X value of Y amount of years you hold it.

After 5, 10, or 15 etc. years you will get back that X amount of cash you paid for that piece of paper originally.

Whats the catch? Every month you get Z amount of cash EXTRA for holding that bond. The longer you’ve decided hold it, the bigger Z you get.

I could be totally wrong and you can delete this, but I recall it goes like this.

It’s basically a loan the government takes from you and the bond is a promise to pay you back and can be redeemed for money at a bank