A sovereign bond is a type of national government bond that is issued in a specific foreign currency. Bonds of this nature typically offer higher returns than other government-issued bonds, but also carry a greater degree of risk. For this reason, it is not unusual for the bonds to be offered at a discount, providing investors with an incentive to purchase the more volatile issues.
One of the strategies associated with the issue of a sovereign bond is to create an influx of cash that can aid in stabilizing the economy of the issuing country. This is often accomplished by denominating the bond in a currency associated with a nation that is currently considered financially stable, rather than the domestic currency. Since a bond is essentially a debt instrument, the funds that are collected through the bond issue are usually referred to as sovereign debt or government debt.
The terms and conditions related to a sovereign bond will vary somewhat, in terms of the rate of interest and the issuance of periodic disbursements to investors. Some bonds are structured so that they are sold at less than the face value, but are ultimately honored at that face value when the bond reaches maturity. Some will utilize a fixed rate as the means of calculating the interest paid to investors, while others utilize a variable rate, often relying on the average rate that prevails in the nation associated with the currency type selected for the bond. Interest payments may occur on a regular basis throughout the life of the bond, or be disbursed to investors in lump sums at the end of the bond’s life, along with repayment of the principal invested in the bond at the time of purchase.
While there is a greater degree of risk associated with a sovereign bond, the potential for earning a higher rate of return is often sufficient to attract the attention of potential investors. As with evaluating any corporate bond issue, investors should look closely at the current economic situation as it relates to the bond issuer, assess the potential for those conditions improving during the life of the bond, then determine if the risk involved is worth the possible returns. Investors should also consider the possibility that in the event the country is unable to honor the terms of the sovereign bond, there is a good chance that some type of alternative compensation may be offered as a means of offsetting the loss to investors.
