Bonds & Interest Rates · Beginner · 4 min

Issuers: governments, companies, covered bonds

You can tell government, corporate and covered bonds apart and explain why each carries a different level of credit risk and yield.

Who borrows matters

Two bonds can have the same maturity, the same coupon and the same face value, and still be completely different investments. The difference is the borrower.

Lending to a large, stable government is not the same as lending to a young company, and a bank that pledges a pool of mortgages as security offers yet another kind of promise. This lesson sorts the main issuers and what stands behind each.

State, company, covered

Comparison Three issuer types: government bonds backed by the state's ability to tax, corporate bonds backed by the business, covered bonds backed by the bank and a pool of loans. Government Backed by tax power Corporate Backed by the business Covered Bank + pool of loans

Government bonds. A government bond is issued by a national government, such as US Treasuries or German federal bonds. It is backed by the state's ability to raise taxes and, in its own currency, often by its central bank's system. Strong governments usually pay the lowest interest in their currency. But governments can and do default, especially when they borrow in a currency they cannot print.

Regions, cities and public agencies also issue bonds. In the US, municipal bonds are a large market of their own.

Corporate bonds. A corporate bond is issued by a company. Its safety depends on the business: its profits, its debt and its industry. The SEC notes that corporate bonds carry the risk that the company cannot pay. In return, they pay more than government bonds of similar maturity. Some are secured by specific assets, many are not.

Covered bonds. A covered bond is issued by a bank and backed by a pool of high-quality loans, typically mortgages or loans to public bodies. The German Pfandbrief is a well-known example. Under the EU covered bond directive, investors have two claims: one against the bank, and, if the bank fails, a priority claim on the pool of assets. This dual recourse makes covered bonds safer than ordinary bank bonds, and they usually pay a little more than government bonds.

The more risk investors see in an issuer, the higher the yield they demand. The next chapters explain how that is measured.

3.0% · 3.4% · 4.5%

Three fictional bonds, all maturing in five years, all in the same currency:

On 10,000, the difference between the government bond and the company bond is 150 a year. That extra income is not free money. It is payment for the chance that the company, unlike the government, cannot pay.

Common mistakes

The takeaway

Who borrows decides the risk. Strong governments pay least, companies more, and covered bonds add a pool of loans as extra security.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

  1. 1Tap the bond type that gives investors a claim on both the bank and a pool of assets.

    Tap the chart.

    Comparison Chart for the question: Tap the bond type that gives investors a claim on both the bank and a pool of assets. Government Backed by tax power Corporate Backed by the business Covered Bank + pool of loans

    The EU covered bond directive gives investors a claim on the issuing bank and, if it fails, a priority claim on the cover pool.

  2. 2Why do companies usually pay higher interest than strong governments?

    Investors want extra yield for extra credit risk. The gap is called the credit spread.

  3. 3What is a German Pfandbrief?

    Pfandbriefe are one of the best-known covered bonds in Europe.

  4. 4Are government bonds free of risk?

    Some governments have defaulted, and every fixed-rate bond carries interest rate risk.

of 4 correct.

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