Government Bondsin simple terms

When a country wants to raise debt finance it does so by way of issuing Government bonds. These are Promissory notes to repay a certain amount of money at a specified date at a specified rate of interest. If a bonds are issued as 10 year bonds in units of €100 at a 3% yield then the bonds state that the government will pay the bond holder a return of 3% per year for ten years. The bonds are traded then on the international markets at prices determined by the yield on the specific bonds and  on the movements in inflation rates and the interest rates pertaining at any time. Obviously at a rate of 3% the variation in prices which can be occur are minimum. The higher the risk level associated with a particular country the higher the yield it has to offer in order to attract investors to buy its bonds. Currently Germany as a highly ranked and stable economy offers an average annual bond yield of 3%. Riskier countries like Ireland, Greece and Portugal have to offer higher bond yields in order to attract investors. So for example the annual bond yield on Greek bonds is 6%.
Historically the yield on bonds was much higher and in the region of 10% and higher. Of course this was also reflected in higher interest rates available through out the world historically. The problem with the current low yields is that if inflation rises, as is the goal of most of the economies of the western world at present (in order to make the economies recover from recession) then the return on the bonds will be nullified and may become negative in real terms. If this happens then you would be better off spending the money now rather than investing it for ten years, as you would buy more products or services per €100 now than you would in 10 years time with all the annual 3%’s added on.
At present there is an abundance of Government Bonds been offered on the international financial markets due to governments having to borrow to stimulate their economies and to shore up the shortfalls in public expenditure created by lower tax takes This is all due to economies been in recession.
As an investment, bonds have the big advantage of a guaranteed return and also of the safety of being offered by governments who are considered to be blue chip borrowers. This means the perceived risk of the bonds not being paid back is low. However in recent times the risk associated with developed western countries has been called into question, with international rating agencies lowering their risk assessment of many countries from the top tier. Certain countries ratings have dropped so low as to be just above been classified as junk stock.
Considering the low return and the risk of inflation eventually eroding the yield on these bonds, in my opinion this wouldn’t be the optimum time to enter the bond market. They are attractive as a very low risk portion of a well diversified portfolio and they will act as a balancing asset against liabilities. However in terms of actual real return from the investment they are not very attractive at present. It all depends on what you are looking for and your attitude to risk. If you want to invest where your money is secure, but which in return for this security offers you a low rate of return, then bonds are the way to go. The Irish Government has plans to follow the lead of other countries and issue national bonds which the public can buy in smaller quantities. The legislation is still being drawn up for these and we await to see how attractive or otherwise they will be.