Investors lend money to the government for a set period of time at a pre-determined interest rate.
When a government issues bonds it will generally make regular interest payments during the life of the bond and repay the initial investment, or principal, when the bonds expire on their ‘maturity date’.
The Commonwealth of Australia issues bonds called Commonwealth Government Securities, which tend to pay a lower rate of interest than corporate bonds.
This is because the Australian Government is generally considered to be of lower risk than companies that also issue bonds.
Low risk, predictable income
Most default superannuation funds will have a proportion of their members' money invested in government bonds because of their low risk and predictable supply of income.
Like shares, some government and corporate bonds can be traded on the ASX. Government bonds that can be traded on the ASX are known as ‘Exchanged Traded Australian Government Bonds’.
There are two main types of Australian Government Bonds (AGBs) that are listed on the Australian Securities Exchange (ASX):
- Treasury Bonds: These are medium to long-term debt securities that carry an annual rate of interest fixed over the life of the security. Interest is paid every six months, at a fixed rate, which is a percentage of the original face value of $100. The bonds are repayable at face value on maturity.
- Treasury Indexed Bonds: These are medium to long-term bonds. The capital value of the bonds is adjusted for movements in the Consumer Price Index (CPI), which measures inflation. Interest is paid quarterly, at a fixed rate, on the adjusted face value. At maturity, investors receive the capital value of the bond - the value adjusted for movement in the CPI over the life of the bond.
The Australian Government has never defaulted on the interest payments on the bonds that it has issued or on the repayment of the principal amount invested in them.
This is why government bonds are considered to be a highly secure investment product, second only to cash at the bottom of the risk spectrum.