Meaning of Federal Bonds

Meaning of Federal Bonds

Bonds are very popular with many investors. For conservative investors, they represent the optimal investment option. After all, Germany enjoys an excellent reputation with rating agencies. The reputation of the state issuing a bond plays a decisive role in the valuation of the paper.

  • Federal bonds are used by the federal government to finance the state.
  • Bonds are also available in very small denominations for small savers.
  • The interest rate is based on the capital market interest rate at the time of issue.
  • The purchase can only be made through a bank.

What are federal bonds?

A federal bond is a fixed income security. In fact, the Federal Republic of Germany is taking out a loan from investors by issuing a bond. Both the issuer risk and the liquidity risk, the risk that the issuer will lose the ability to pay interest or repurchase bonds are marginal. The bond guarantees the buyer a fixed annual interest payment for the duration of the bond.

Bonds are issued to the Traded on the stock exchange. That means they have a “course”. Bonds are always issued close to the market value of 100 percent, for example 99.75 percent or 100.5 percent. The price of 100 percent of a federal bond always corresponds to the nominal value. Bonds are available for as little as EUR 0.01, a size that is, however, irrelevant. Nevertheless, the denomination is chosen so that even small investors can purchase federal bonds.

Bonds are among the so-called hand-safe investments. This means that a guardian can invest the money of his ward in federal bonds, since the risk of loss is excluded.

The yield on a federal bond

If an investor wants to buy bonds for 1,000 euros, the issue price is 100.5 percent, he has to pay 1,005 euros for them. The Federal Ministry of Finance managed to earn money by borrowing during the low interest rate phase. The issue price of the bond exceeded the interest rate. The outstanding creditworthiness of the Federal Republic of Germany justifies the fact that institutional investors in particular accept the loss of interest.

An issue price of more than 100 percent reduces the Return on the bond, less than 100 percent increases the return.

The return is the return that a bond has generated after it has been sold by the investor. It is made up of the interest and the price gain or loss on sale or redemption. If the investor buys the paper at a price of 100.5 percent one year before the bond matures and receives an interest rate of 1.5 percent, the return for this period is 1 percent: 1.5 percent minus 0.5 percent price above 100 .

It also applies to federal bonds that when capital market rates rise, the price of the lower-interest bonds in circulation falls. Conversely, falling interest rates mean that the price of the paper rises. A rule of thumb for German government bonds states that a one percent increase in capital market interest rates leads to a price discount of nine percent for securities that are already placed on the market.

Inflation-linked federal bonds

In addition to the classic bond, the federal government also offers inflation-indexed federal bonds. These offer an interest rate that increases slowly over the years and is linked to an inflation index. The Federal Republic has issued these bonds since 2006. As an alternative to the rising interest rate, a redemption price that rises compared to the issue price can also be part of the bond. The loss of inflation, especially with long-term fixed-income securities, means that when the bond is returned, the investor gets less money back than he invested in terms of purchasing power.

How can you buy federal bonds?

The prerequisite for acquiring a government bond is that the investor has a securities account with a bank, savings bank or broker. Free storage and free purchase from the Federal Debt Administration are no longer possible. In the case of a new issue, the first issue, the securities are sold through the Deutsche Bundesbank commissioned by the finance agency. From the initial issue, federal bonds will be traded on the stock exchange every trading day. Since the trading volume of these securities is very large, there are no outliers in the prices. These are close together in the course of trading, which always means a fair price for the buyer.

For the investor, in addition to the market value that he has to pay, there are also brokerage fees, stock exchange fees and the costs of the custodian bank for the purchase.

Bonds with a ten-year term

Bonds are issued with two maturity options. The short version is ten years, the longer version 30 years. The advantage of the short-term loan is that if the interest rate changes, the investor can get the bond bought back by the federal government relatively quickly. Interest rates do not change significantly in two or three years, so that one can speak of “fast” at ten years.

Bonds with a 30-year term

These papers are particularly attractive in times of relatively high interest rates. They guarantee the investor an attractive dividend over a long period of time. On the other hand, if interest rates rise over the years, these bonds lose a lot of their market value. A sale during the term of the bond becomes uninteresting for the investor; he usually has to wait for the redemption date. However, it is more institutional investors who opt for paper with a term of 30 years.

Overview of federal securities

In addition to federal bonds, the Federal Republic of Germany issues other securities that differ primarily in terms of maturity. The federal securities include:

  • Bonds with a term of 10 or 30 years
  • Federal bonds with a 5-year term
  • Federal treasury notes with a term of 2 years
  • Treasury discount bills 12 months maturity
  • inflation-indexed federal securities

Federal Treasury Bonds, also very popular, and day bonds have not been issued since 2013. In 2017, the federal government also stopped issuing interest-free Treasury notes with a term of six months.