Understanding Sovereign Bonds: Risks & Rewards

A sovereign bond is just one of the many types of bonds that are available for you to invest in. These government-issued bonds offer a higher yield, but they offer also a higher level of risk.

Definition of a Sovereign Bond

A sovereign bond is issued by a country’s government, but unlike a government bond, which is issued in the country’s own currency, sovereign bonds are issued in a foreign currency. This is often done by nations whose currency is subject to high inflation rates or unstable exchange rates. In these cases, it is actually more economical to issue the bonds in a foreign currency.

Risk/Reward of Sovereign Bonds

The main risk involved with these bonds is what is called sovereign default. This occurs when the nation that issued the bond is unable to repurchase the bonds at the bond repayment time. Because of this risk, investors will demand a higher yield from the bond. However, this is a catch-22 scenario since the higher yield will make it harder for the government to service the debt. In the rare instance that a nation cannot repay the bond, they can present an exchange offer as an alternative.