National debt: what are federal bonds? | tagesschau.de


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Status: 13.10.2022 4:55 p.m

The state will take in around 400 billion euros this year from federal securities. What are they and how do they work.

By Till Bücker, tagesschau.de

According to the Basic Law, the state is obliged to balance the income and expenditure. If the taxes are not enough to cover the costs, he has to take on debt to finance the household. According to Commerzbank, 98 percent of German government debt consists of listed securities, of which around 80 are in circulation. These include government bonds.

How the state borrows money

“In very general terms, a bond is a security that entitles the holder to receive certain interest payments every year and to get the full principal amount back at the end of the term,” explains Friedrich Heinemann from the Leibniz Center for European Economic Research ZEW in an interview tagesschau.de. By issuing bonds, states borrow money from investors for several years and pay interest on it.

The issuance or replenishment of such investments works through auctions. For 2022 alone, the issue volume will total 410 billion euros. In the so-called tender process, the members of a fixed group of bidders can submit bids within a certain period of time via the Bund Bidding System (BBS). According to the Bundesbank, Germany is auctioning off the securities to 32 domestic and foreign commercial banks. Finanzagentur GmbH is responsible for this. After the deadline, she allocates the titles depending on the respective bid. The buyers can ultimately keep them themselves or resell them at a premium – for example to institutional or private investors.

“The owner of the bond can sell it again on the stock exchange every day,” says Heinemann. Especially the bonds of the Federal Republic of Germany can be traded at any time. The majority of federal bonds are in the hands of life insurance companies, funds and banks and thus also indirectly belong to private savers, emphasizes the head of the ZEW research department Corporate Taxation and Public Finance. “German government bonds are considered very safe because there is a high belief that Germany will always be able to keep its promise to pay in the years to come.” Rating agencies rate the creditworthiness, also known as creditworthiness, of Germany with the top grade AAA.

Ten-year government bonds most common

Risk-averse investors therefore typically invest in government bonds. The federal government offers them various papers that differ in terms of interest rate and term. Bonds that have a term of up to two years are called Federal Treasury Notes. Five-year bonds are called federal bonds. There are also green securities, the income from which is used exclusively for the climate and the environment, as well as inflation-indexed products, where the interest rate is based on inflation. The classic federal bonds are those with a term of seven, ten, 15 or 30 years. According to the finance agency, these account for more than 60 percent of Germany’s debt portfolio.

“The most common bond is the ten-year one,” emphasizes economist Heinemann. In fact, 40 percent of federal bonds are papers with a term of ten years. At around 12.8 percent, they have the third-largest share of the federal government’s total annual issuance volume and are also traded the most. Why is that? In addition to the round number, one reason is that every state has securities with this term, says Heinemann. That makes them internationally comparable. The ten-year federal bond is therefore a particular focus on the financial market.

Because there are many such papers in circulation, the last one issued is always decisive. This “recent” ten-year bond is the most responsive to news in the world and very liquid. This is the best way to describe the current interest rate level. Its yield is published daily by the Deutsche Bundesbank.

How the return is calculated

Yield is the effective interest rate on a bond and is therefore a measure of the success of an investment after the agreement has expired or when it is sold. One aspect is the runtime. There is higher interest for longer bonds, since investors have longer to lose their money – with all the risks. Above all, however, the interest rate and the price are decisive for the return on a federal bond.

“If a bond is worth EUR 100 when it is issued and has an annual interest rate of three percent, the interest coupon is also the annual return,” explains Heinemann. This yield calculation assumes that the investor holds the bond until maturity. However, the bond is constantly being traded in the market and the price is constantly changing. If many investors throw their papers out of the portfolio, the price falls. However, when demand increases, it climbs up. This has consequences for returns.

“If the rate falls from 100 to 90 euros, you have to relate the interest to the new rate, and the return increases to 3.33 percent,” says the expert. Accordingly, yields and prices on the bond market develop in opposite directions. If the prices fall with an interest rate fixed for the entire term, the returns for investors who are new to them increase – and vice versa. This price effect is greater the longer the remaining term of the bond.

Inflation also changes returns

In addition, expectations play a major role. Therefore, when the market interest rate goes up, and vice versa, the price goes down. The key interest rates are relevant for the banks that take out loans from the currency watchdogs. This in turn has an effect on the capital market interest rates that, among other things, the states have to offer investors for the money on the bond market. If the key interest rates go up, higher interest rates for federal bonds are therefore expected. Because investors are hoping for better returns in the medium to long term, they are selling existing bonds.

Inflation also has a negative effect on the price. If this is too high, the fixed interest rate does not compensate for the price increases, so investors lose money in real terms. “The real value of 100 euros in government bonds that I have in my portfolio falls to 90 euros with inflation of ten percent,” explains ZEW economist Heinemann. Government bonds must always be viewed with inflation in mind. Because even if the interest rate and thus the yield on Bunds rose nominally, the real interest rate would actually fall.

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