Government bonds: what they are, what they are and how they work

Government bonds are considered safe and reliable investments for investing savings, especially in a context characterized by high interest rates.
At the same time, they provide the National Treasury with the necessary means to support public expenditure.
But how does all this happen? Government bonds are available in various forms and durations, adaptable to the needs of each investor.
Once purchased, they guarantee a periodic flow of interest that varies based on the maturity and specific characteristics of the security.
In this guide we explore in detail the most purchased government bonds at the moment, analyzing the different existing types and identifying those that offer the best advantages for aware investors.
Government bonds, the complete guide What are government bonds and how do they work What are government bonds: the different types Government bonds: yield, interest and maturity How to calculate the yield Effective yield and tax rate When is it best to invest in government bonds state What are government bonds and how do they work Italian government bonds, issued by the Italian Republic through the Ministry of Economy and Finance and placed by the Bank of Italy, represent a fundamental means through which the State finances itself.
Whoever invests in these securities becomes a creditor of the State, granting funds necessary to satisfy debt needs, finance institutional activities and cover the country's needs.
The way government bonds work is relatively simple: investors buy these bonds, providing money to the state, and in exchange receive a return in the form of interest.
These interests can vary depending on market conditions and the type of security, offering investors a potential gain over time.
Upon maturity of the security, investors are entitled to a refund of the capital invested.
In essence, government bonds offer a safe and stable form of investment, suitable for both private and institutional investors, and contribute to the financing of government activities, offering a long-term earning opportunity.
What are government bonds: the different types There are seven types of government bonds issued by the Italian Republic.
These securities, accessible to both private and institutional investors, have different characteristics in terms of duration, indexation and methods of interest remuneration.
The types of government bonds can be grouped into three macro-categories: Zero coupon bonds: these bonds do not provide for the payment of periodic coupons.
Among them we find Treasury Ordinary Bonds (BOT), with short maturities (3, 6, or 12 months), and Zero Coupon Treasury Certificates (CTZ), with maturities of 24 months; Variable rate securities: these securities, however, offer coupons whose remuneration varies over time.
Among them there are Treasury Credit Certificates (CCT) and Treasury Credit Certificates (CCTeu), with a maturity of 7 years; Fixed rate securities: finally, these securities guarantee a constant interest rate over time.
Among the fixed rate securities we find the Multi-year Treasury Bonds (BTP) with various maturities (3, 5, 10, or 15 years), the BTP Green, the BTP€i (indexed to European Inflation), the BTP Italia ( indexed to Italian inflation), BTP Valore (with increasing nominal coupons) and multi-year step-up Treasury Bonds reserved for retail investors (BTP Futura).
These different types of government bonds allow investors to choose the option that best suits their needs and investment strategies.
read also Italian government bonds: taxation of interest and capital gains.
The complete guide Government bonds: yield, interest and maturity The yield on government bonds represents the return on the investment made and includes both interest and capital gain.
This yield, known as Yield to Maturity (YTM) or yield to maturity, is calculated using the formula for discounting future cash flows, as we will see later.
Investing in government bonds is generally suitable for investors with a low risk appetite as these bonds are guaranteed by the state.
However, as is known, a low risk profile is also associated with a lower remuneration which, in securities with coupons, is in any case periodic and constant.
The yield is expressed as a percentage and measures the returns compared to the initial investment on the bond, which mainly depend on two main factors: on the coupons collected during the life of the bond, which can be considered, for simplicity, equal to the last detached coupon or current coupon, in the case of variable rate bonds such as CCTeus and BTPi among Italian government bonds; from the capital gain, given by the difference between the purchase price and the redemption or sale price on the secondary market, in the case of disinvestment before maturity.
How to calculate the return To correctly calculate the return, it is necessary to use the discounted flow formula of future cash.
This formula takes into account the present value of each future cash flow, including the redemption value, and will return a bond price that is fair based on the discount rate used in the calculations.
In essence, this formula takes into account the concept of the time value of money, which holds that a euro received today is worth more than a euro received in the future, due to the potential gain resulting from its immediate investment.
The effective yield, also known as YTM, is the annual interest rate that balances the current price of the bond with its market price, taking into account the interest accrued up to that point.
This rate is found by using the formula for discounting future flows and associating the actual yield with the current price of the bond.
If the discount rate coincides with the actual yield of the security, the same market price is obtained, increased by the interest rate.
The yield also depends on the maturity.
The relationship between yield and maturity is called the “term structure” of interest rates.
The yield curve graph is like a map showing the relationship between the yield and the time left until maturity for a group of similar bonds.
This chart helps investors understand how returns vary based on the remaining term of their investment.
Effective yield and tax rate In summary, the effective yield depends on several factors, including the degree of subordination of the bond, the ratings assigned to the issuer by international agencies, the presence of problems in early redemption and the maturity of the bond.
Therefore, it is essential to consider the market context and relevant indicators to correctly evaluate the yield of a government bond.
We remind you that the proceeds deriving from government bonds enjoy a preferential tax rate of 12.5%, calculated on the capital gain realized.
read also How is the yield on a bond calculated? When it is best to invest in government bonds Investing in government bonds is convenient for those who have liquidity to invest and wish to avoid excessive risks, opting for a regular flow of interest rather than leaving savings in the current account, especially in market phases characterized by high rates of interest.
It is also a useful strategy for those looking to diversify their portfolio, balancing risky investments with the safer ones offered by government bonds.
The convenience of this type of investment depends on several factors, including: the duration of the government bond; the outlook for inflation and the probability of an interest rate cut by the ECB; the ability to sell securities before maturity; the time horizon of the investment.
To determine whether a particular government bond is worth it, it is critical to compare its yield to that offered by other government bonds with similar maturities.
Only through an objective analysis is it possible to seize the most advantageous investment opportunities, perhaps taking advantage of benefits such as discounts on purchase commissions and loyalty rewards for holders until maturity.
If the investor's goal is to protect himself from inflation, it may be interesting to consider inflation-linked government bonds, provided that inflation is expected to rise in the near future.
However, it is important to carefully compare inflation expectations with the yields offered by different types of government bonds to find the option that best suits your needs and expectations.