Risk-Free Government Bonds Are Called Risk-Free Because Term Paper

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Risk-Free

Government bonds are called risk-free because they will be paid back. The underlying assumption is that the U.S. Treasury can always print more money in order to finance the payback of these bonds. That does not by any means make the bonds truly risk-free, but they are guaranteed to return face value. There are actually a few different ways in which government bonds are risky.

A recent change to the more orthodox view of government bond risk is that U.S. government bonds were downgraded in 2011, something that had never happened previously. This has not changed the market view of U.S. government paper, but it does imply that, according to one rating agency at least, the bonds of some other governments are less risky than the bonds of the U.S. government. That said, the risk conditions of U.S. bonds have not changed. They are still considered risk free because the Treasury will still print money to pay them back, and because there is still no credible risk of default unless the political situation worsens and even more economically illiterate people get into Congress.

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The first source of risk in government bonds lies with the time frame. The longer the time frame, the greater the risk of something catastrophic happening to allow the possibility of default. Given this, bonds with longer terms to maturity carry slightly higher interest rates to compensate for the risk represented by time. In addition, longer-term government paper also bears interest rate risk, that is the risk that interest rates will change in the interim, devaluing the bond if sold before maturity.

The risk of default in U.S. government bonds, aside from political shenanigans like the debt ceiling debacle in the summer of 2011, lies largely with the federal budget. This is known as….....

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