What Are Government Bonds and How Do They Work?

Government bonds are one of the most widely used financial instruments in the world. They allow governments to raise money for public spending while giving investors a relatively safe way to earn predictable returns. In 2024, the global bond market was valued at more than $133 trillion, with UK government bonds forming a significant share of Europe’s debt market. This guide explains what government bonds are, how government bonds work, why they matter, and how you can buy them.

What Are Government Bonds?

Government bonds are debt securities issued by a country’s government to raise money. When you buy a government bond, you are essentially lending money to the government. In return, the government agrees to pay you interest (known as the coupon) at regular intervals and return your initial investment (the principal) when the bond matures.

For example, if you purchased a 10-year UK gilt in 2025 with a 4% coupon, a £5,000 investment would return £200 per year, plus the full repayment at maturity. At the end of 10 years, the government would repay your original £5,000. This makes government bonds attractive to investors seeking predictable income and relatively lower risk than equities.

How Do Government Bonds Work?

Government bonds are first issued through auctions in the primary market, and then traded in the secondary market where prices move according to demand, interest rates, and wider economic conditions.

Some common bond terms include:

• Face Value (Par Value): The amount you initially invest, typically £100 or £1,000 per bond.
• Coupon Rate: The fixed annual interest rate the government pays, expressed as a percentage of the face value.
• Yield: The effective return you earn, which changes if you buy or sell the bond in the secondary market.
• Maturity Date: The date when the government repays the bond’s face value.

The process works as follows:

1. You purchase a bond at its face value.
2. You receive coupon payments, usually every six months or annually.
3. At maturity, you receive your original investment back.

For example, if you purchased a UK gilt in 2025 with a 4% coupon, a £1,000 investment would return £40 annually, with the full amount repaid at maturity. This provides a steady income and relatively low risk compared with shares. However, if you decide to sell before maturity, the price you receive will depend on market conditions. In 2025, yields on 10-year UK government bonds hovered around 4.1%, and even small changes in yield could affect the value of your bond in the secondary market.

Types of Government Bonds

There are several types of government bonds, each designed for different time horizons and purposes:

• Treasury Bills (T-Bills): Very short-term securities that mature in less than a year, often in 3-, 6-, or 12-month terms. They are usually sold at a discount, meaning you pay less than the face value and receive the full amount at maturity.
• Treasury Notes (T-Notes): Medium-term bonds with maturities between 2 and 10 years. They pay a fixed coupon every six months and are a popular choice for investors who want regular income but not a very long commitment.
• Treasury Bonds (T-Bonds): Long-term government debt with maturities of 20 to 30 years. Because your money is tied up longer, they tend to offer higher coupon rates, but their prices are more sensitive to interest rate changes.
• Inflation-Linked Bonds: Also known as index-linked bonds, these are designed to protect investors from inflation. In the UK, these are called index-linked gilts, while in the US they are known as TIPS (Treasury Inflation-Protected Securities). Both adjust their principal and interest payments based on inflation, helping preserve your purchasing power.

Example: In the UK, government bonds are known as gilts, and in Japan, they are called JGBs (Japanese Government Bonds). In 2024, 10-year JGB yields moved above 1% for the first time in over a decade, showing how even traditionally low-yielding markets are shifting.

Why Do Governments Issue Bonds?

Governments issue bonds for several key reasons:

• Finance public spending: To fund infrastructure projects, healthcare, defence, and education.
• Manage national debt: Bonds help refinance existing obligations without immediate tax hikes.
• Stabilise the economy: During downturns, issuing bonds allows governments to inject money into the system.
• Maintain cash flow: Bonds provide a steady source of funding to cover budget gaps.

For example, the UK’s national debt exceeded £2.6 trillion in 2025, much of it supported by issuing UK government bonds. Similarly, the US national debt passed $34 trillion, financed largely through Treasury bonds.

Why Do Investors Buy Government Bonds?

Investors purchase government bonds for several reasons:

• Safety: Government bonds are backed by the issuing government, making them among the safest investments available. For example, UK government bonds are considered low-risk compared with corporate debt or equities.
• Income: Bonds provide fixed coupon payments, usually every six months. This predictable cash flow appeals to those seeking stability, such as retirees or income-focused investors.
• Diversification: Adding government bonds to a portfolio helps balance riskier investments like shares. They often perform well during market downturns, offsetting stock volatility.
• Liquidity: Many government bonds, particularly from developed markets like the UK or US, are highly liquid. This means you can usually buy or sell them quickly in the secondary market without large price discounts.
• Benchmark Role: Government bonds serve as benchmarks for other interest rates in the economy. By holding them, you gain exposure to an asset class that influences borrowing costs on mortgages, corporate loans, and even international trade.

During the turbulence of 2022–2023, many investors shifted into government bonds. By 2024, 10-year UK government bond yields averaged around 4%, showing their continuing role as a safe haven in uncertain times.

How to Buy Government Bonds

There are three main ways you can gain exposure to government bonds, depending on whether you want to own the bonds or trade them through derivatives like CFDs.

1. Buying New Bonds at Auction (Indirectly via Brokers)

Retail investors in the UK cannot place bids directly with the Debt Management Office (DMO) during auctions. However, several brokers and investment platforms route retail orders through Gilt-Edged Market Makers (GEMMs), so you can still access new issues at the auction price.

• Step 1: Open an account with a broker or platform that offers retail access to new gilt issues.
• Step 2: Review the DMO auction calendar to see upcoming gilt offerings.
• Step 3: Place your order through the platform, which will be submitted via a GEMM, allowing you to buy bonds at the auction price.
• Step 4: If accepted, you will receive your allocation at the auction price.

This option is best if you want to lock in the coupon rate and hold the bond until maturity.

2. Buying Existing Bonds in the Secondary Market (Through Brokers)

Most UK retail investors buy gilts and other government bonds through brokers in the secondary market. This gives you flexibility to choose the maturity, yield, and amount that suit your needs.

• Step 1: Open a brokerage account that offers access to UK gilts or other government bonds.
• Step 2: Search for the bond you want to buy and review key details such as maturity, coupon, and price.
• Step 3: Place an order in multiples of £100 nominal.
• Step 4: Hold the bond and collect coupon payments until maturity, or sell it in the market if you wish.

This is the most practical route if you want to own government bonds directly and generate coupon income.

3. Trading Government Bond CFDs or Futures with VT Markets

If you prefer not to hold bonds but want to speculate on their price movements, you can trade government bond CFDs or futures with VT Markets. This approach allows you to go long or short, use leverage, and trade actively without waiting for maturity or receiving coupons.

• Step 1: Open and fund a VT Markets trading account.
• Step 2: Choose the bond market you want to trade, such as UK gilts, US Treasuries, or German Bunds.
• Step 3: Analyse the market using economic news and technical tools to assess potential bond price movements.
• Step 4: Decide your direction by buying (going long) if you expect prices to rise, or selling bonds (going short) if you expect them to fall.
• Step 5: Set your trade size, stop-loss, and take-profit orders.
• Step 6: Place the trade and monitor it, closing your position when your target is reached.

This method is best if you want flexibility, leverage, and short-term opportunities rather than fixed coupon income. However, remember that while leverage can amplify potential gains, it also magnifies losses if markets move against you. Always manage risk with tools such as stop-loss orders.

Factors Affecting Government Bond Prices

The price of a government bond does not stay fixed. It changes daily based on wider economic and market conditions. The main factors include:

1. Interest Rates

Bond prices and interest rates move in opposite directions. When central banks raise rates, newly issued bonds pay higher coupons, which makes older bonds with lower coupons less attractive. As a result, the price of existing bonds falls. Conversely, when rates are cut, existing bonds paying higher coupons become more valuable, pushing their prices up.

2. Inflation

Inflation reduces the real purchasing power of future coupon payments. If inflation rises above the bond’s coupon rate, investors demand a discount to compensate, lowering the bond’s price. This is why inflation-linked bonds, such as UK index-linked gilts, often perform better in high-inflation environments.

3. Credit Risk

The perceived creditworthiness of a government affects how investors value its bonds. Developed markets like the UK or Germany are considered very safe, so their bonds trade at higher prices and lower yields. By contrast, emerging markets with weaker credit ratings often see bond prices fall and yields rise because investors require more compensation for the added risk.

4. Market Demand

Investor appetite plays a big role in setting bond prices. If pension funds, central banks, or global investors are buying heavily, demand pushes prices higher and yields lower. When demand weakens, perhaps because investors prefer equities or other assets, bond prices drop.

Example: When the Bank of England kept its base rate at 5.25% in 2024, yields on UK government bonds remained elevated. This was because higher interest rates reduced demand for existing bonds, showing how monetary policy directly affects bond valuations.

Risks and Limitations of Government Bonds

Although government bonds are widely seen as low-risk, safe-haven assets, especially when compared with corporate bonds or shares, they are not risk-free. The main risks include:

1. Interest Rate Risk

When interest rates rise, the prices of existing bonds fall. This happens because new bonds are issued with higher coupon rates, making older bonds less attractive. For example, if you hold a bond paying 2% while new issues pay 4%, investors will only buy your bond at a discount.

2. Inflation Risk

Inflation reduces the real value of the bond’s fixed coupon payments. If inflation rises above the bond’s yield, your purchasing power falls even though you still receive the same cash payments. This is why many investors prefer inflation-linked bonds, such as UK index-linked gilts, during periods of high inflation.

3. Default Risk

While rare in advanced economies like the UK or Germany, some governments may fail to meet their obligations. This “sovereign default” risk is higher in emerging markets with unstable economies or weak fiscal positions.

Example: In 2023, Argentina suffered a government bond crisis, with some bonds trading at less than 30 cents on the dollar. This illustrated how default risk can cause severe losses for investors holding bonds in weaker economies.

Government Bonds: Key Takeaways

Government bonds are vital tools for governments to raise funds and for investors to access safer, income-generating assets. By understanding what government bonds are and how government bonds work, you can see how they fit into both long-term investment strategies and short-term trading opportunities. Their prices are shaped by factors such as interest rates, inflation, credit quality, and demand, which means they carry risks including rate changes, inflation pressure, and in some markets, default.

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Frequently Asked Questions (FAQs)

1. What are government bonds in simple terms?

Government bonds are debt securities issued by a country’s government to raise money. When you buy them, you are lending money to the government in return for fixed interest payments and repayment of your capital at maturity.

2. How do government bonds work?

Government bonds pay a fixed coupon, usually semi-annually or annually, and return your original investment when they mature. Their market value can rise or fall depending on interest rates, inflation, and investor demand.

3. Are UK government bonds different from other government bonds?

UK government bonds are called gilts. They operate in the same way as other bonds but are widely regarded as very low risk, backed by the UK government’s creditworthiness.

4. How to buy government bonds as a beginner?

You can buy UK government bonds through brokers in the secondary market, or trade them via CFDs and ETF CFDs with VT Markets using platforms like MetaTrader 4 (MT4) and MetaTrader 5 (MT5).

5. Why do investors choose government bonds?

Investors buy government bonds for their safety, predictable income, and diversification benefits. They often act as a safe haven when stock markets are volatile.

6. Can you lose money with government bonds?

Yes. If you sell before maturity, you may receive less than you invested if prices have fallen. Inflation can also erode real returns, and in rare cases, some governments may default.

7. Are government bonds risk-free?

No investment is completely risk-free. While bonds from countries like the UK, US, and Germany are considered very safe, they are still exposed to interest rate and inflation risks.

8. Can I trade government bonds instead of owning them?

Yes. With VT Markets, you can trade government bond CFDs and bond ETF CFDs, allowing you to speculate on price movements without owning the underlying bonds.