by D. Vogt

Created on: August 31, 2010

A sovereign bond is a bond issued by the national government of a country. Sometimes this type of bond is further subdivided into "government" bonds, issued in the national currency of the government in question, and true sovereign bonds, issued in other, foreign currencies. In most basic respects sovereign bonds are identical to other forms of bonds: they are, in essence, contracts under which a principal sum of money is loaned until a particular future repayment date, and interest on that principal is paid in the meantime. However, whereas private bond issuers may go bankrupt, governments which fall into severe political and economic straits may enter into the more complicated situation of sovereign default.

A bond is, in essence, a type of loan. (This makes them different from the other most common investment vehicle, stocks, which are shares in the ownership of a company.) A certain amount of money is loaned - the initial "purchase" price of the bond - and it is repaid at a future date, with interest accumulating in the meantime. The bond is the contract which specifies the amount of money to be loaned, the date at which it will be repaid, and the rate at which interest will accumulate in the meantime. The interest rates set are generally determined by the creditworthiness of the bond issuer, in much the same way as individuals' home mortgage interest rates reflect their credit score. A bond issuer with a poor credit rating must offer higher interest rates in order to attract investors, who will fear that a shaky company may go bankrupt and fail to pay back some or all of the principal.

Sovereign bonds issued by governments share all of these basic principles with bonds issued by other organizations, including private corporations, other levels of government (municipal, state, and provincial bonds in various countries), and international financial institutions like the World Bank. They also have credit ratings assigned by the bond ratings companies, such as Standard & Poor's (now owned by McGraw-Hill), Moody's (MCO), and the Dominion Bond Rating Service (DBRS). These ratings range from Aaa (a spotless record with virtually no risk of default) through B, C, and D, implying progressively greater risk, up to the point that the government or corporation in question is almost guaranteed not to make its proper payments.

From the perspective of investors, the principal difference between corporate bonds and government or sovereign bonds is the greater capacity

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