Government bonds are bonds issued by governments to raise funds.
In Japan, in addition to “JGBs for Retail Investors,” which are designed to be easy for individuals to purchase, there are also “New OTC JGBs,” through which ordinary government bonds traded in the market can be purchased through financial institutions and other channels, as well as “previously issued JGBs,” which have already been issued and are traded in the market.
Government bonds are generally treated as financial products with smaller price fluctuations than stocks and similar investments, but depending on the product, market prices may fluctuate, and selling before maturity may result in a loss of principal.
In addition, even for the same government bond, the “coupon rate” and “yield” do not mean the same thing, and actual profitability varies depending on the purchase price.
This article organizes the basics of what government bonds are, the differences between JGBs for Retail Investors, New OTC JGBs, and previously issued JGBs, the relationship between government bond prices and interest rates, how to read yields, U.S. Treasury securities, and what happens when government bonds are sold before maturity, as a foundation for learning about asset management.
Note:
This article is a personal study note for learning about government bonds and asset management. It does not recommend investing in any particular government bond, financial institution, securities company, foreign bond, or other product. Government bond interest rates, offering prices, yields, taxes, transaction terms, and other conditions may change. When actually making a purchase, check the latest information published by the Ministry of Finance, financial institutions, securities companies, and other relevant organizations.
- What Are Government Bonds?
- How Profits Are Generated from Government Bonds
- What Are JGBs for Retail Investors?
- Differences Between 3-Year Fixed, 5-Year Fixed, and 10-Year Floating
- Which Is More Advantageous, Fixed or Floating Interest Rates?
- What Happens If You Redeem JGBs for Retail Investors Early?
- What Are New OTC JGBs?
- Differences Between JGBs for Retail Investors and New OTC JGBs
- Difference Between the “Coupon Rate” and “Applicant Yield” of New OTC JGBs
- Why the Prices of New OTC JGBs Fluctuate
- Government Bond Prices and Yields Move in Opposite Directions
- What Are Previously Issued JGBs?
- Items to Check When Looking at Previously Issued JGBs
- How to Read the Yield of Previously Issued JGBs
- What Is Remaining Maturity?
- Previously Issued JGBs with Short Remaining Maturities
- What Are U.S. Treasury Securities?
- Investing in U.S. Treasury Securities from Japan Involves Foreign Exchange Risk
- What Are STRIPS for U.S. Treasury Securities?
- What Happens If Government Bonds Are Sold Before Maturity?
- Difference Between Holding Until Maturity and Selling Before Maturity
- Government Bonds Also Have Risks
- Inflation and Government Bonds
- Items to Check When Looking at Government Bonds
- Consider JGBs for Retail Investors Separately from Government Bonds Traded in the Market
- Summary
- References
What Are Government Bonds?
Government bonds are bonds issued by governments to borrow funds from investors and others.
When an investor purchases a government bond, it is similar to lending money to the government for a certain period.
With interest-bearing government bonds, predetermined interest is received during the holding period, and at maturity, the face value is generally repaid.
Example:
If you hold a government bond with a face value of ¥100,000 until maturity, an interest-bearing government bond will pay interest during the holding period, and at maturity, the face value of ¥100,000 will generally be repaid.
Government bonds issued by the Japanese government are called “Japanese Government Bonds,” while government bonds issued by the U.S. government are called “U.S. Treasury securities.”
Government bonds differ depending on the issuing country in terms of creditworthiness, interest rates, currency, price fluctuations, and other factors.
How Profits Are Generated from Government Bonds
The main types of returns that can be obtained from government bonds include the following.
- Interest received while holding the bond
- The difference between the purchase price and the redemption amount at maturity
- The difference between the purchase price and the selling price when sold before maturity
The way profits and losses arise differs between products such as JGBs for Retail Investors, which are purchased and redeemed early based on face value, and products such as New OTC JGBs and previously issued JGBs, which are affected by market prices.
What Are JGBs for Retail Investors?
JGBs for Retail Investors are Japanese Government Bonds designed to be easy for individuals to purchase.
There are three types: “10-Year Floating Rate,” “5-Year Fixed Rate,” and “3-Year Fixed Rate.”
They can be purchased from a minimum of ¥10,000 in units of ¥10,000, and the offering price is ¥100 per ¥100 of face value.
Interest is paid twice a year, every six months.
In addition, all products have a minimum annual interest rate of 0.05%.
Main Features of JGBs for Retail Investors
- Only individuals can purchase them
- They can be purchased from a minimum of ¥10,000 in units of ¥10,000
- There are 10-Year Floating Rate, 5-Year Fixed Rate, and 3-Year Fixed Rate products
- Interest is received twice a year
- A minimum interest rate is set
- In principle, they can be redeemed early after one year has passed since issuance
- The redemption amount at maturity is ¥100 per ¥100 of face value
Differences Between 3-Year Fixed, 5-Year Fixed, and 10-Year Floating
JGBs for Retail Investors are available in three types: “3-Year Fixed,” “5-Year Fixed,” and “10-Year Floating.”
| Product | Maturity | Interest Rate Type | Main Feature |
|---|---|---|---|
| 3-Year Fixed | 3 years | Fixed rate | The interest rate determined at purchase remains unchanged until maturity |
| 5-Year Fixed | 5 years | Fixed rate | The interest rate determined at purchase remains unchanged until maturity |
| 10-Year Floating | 10 years | Floating rate | The applicable interest rate is reviewed every six months |
3-Year Fixed
The 3-Year Fixed product is a JGB for Retail Investors with a three-year maturity.
It is a fixed-rate product in which the interest rate determined at purchase remains unchanged until maturity.
The applicable interest rate is determined by subtracting a certain amount from the reference interest rate.
Because the interest rate is determined at the time of purchase, it is relatively easy to understand the amount of interest that will be received if the bond is held until maturity.
5-Year Fixed
The 5-Year Fixed product is a JGB for Retail Investors with a five-year maturity.
As with the 3-Year Fixed product, the interest rate determined at purchase remains unchanged until maturity.
Therefore, even if market interest rates later decline, the interest rate received does not change.
On the other hand, even if market interest rates later rise significantly, the interest rate on the 5-Year Fixed product already purchased does not increase.
10-Year Floating
The 10-Year Floating product is a JGB for Retail Investors with a 10-year maturity, and the applicable interest rate is reviewed every six months.
Because the applicable interest rate is determined based on the reference interest rate, the amount of interest received may increase when market interest rates rise.
Conversely, if market interest rates fall, the applicable interest rate may also decline.
However, JGBs for Retail Investors have a minimum interest rate.
Which Is More Advantageous, Fixed or Floating Interest Rates?
Whether fixed or floating interest rates are more advantageous depends on future market interest rates.
If Interest Rates Rise:
With the 10-Year Floating product, the interest received in the future may increase through the semiannual interest rate review.
With the 3-Year Fixed and 5-Year Fixed products, the interest rate determined at purchase continues unchanged.
If Interest Rates Fall:
With the 3-Year Fixed and 5-Year Fixed products, the interest rate set at purchase continues until maturity.
With the 10-Year Floating product, the applicable interest rate may decline later.
Because future interest rates cannot be predicted accurately, it is necessary to understand the maturity period and whether the interest rate is fixed or floating when making a choice.
What Happens If You Redeem JGBs for Retail Investors Early?
In principle, JGBs for Retail Investors cannot be redeemed early for one year after issuance.
Once one year has passed since issuance, some or all of the bonds can generally be redeemed early in units of ¥10,000.
In this case, they are not sold at market price but are redeemed through repurchase by the government.
When redeemed early, an “early redemption adjustment amount,” calculated in principle based on the amount equivalent to the previous two interest payments, is deducted.
Concept:
With JGBs for Retail Investors, even if market interest rates rise and bond prices fall, they are not sold at the ordinary market price.
Instead, they are redeemed early by the government after a specified early redemption adjustment amount is deducted.
This is a major difference from New OTC JGBs and previously issued JGBs, which are explained later.
What Are New OTC JGBs?
New OTC JGBs are a system through which Japanese Government Bonds normally issued in the market can be purchased through financial institutions and other channels.
They are separate products from JGBs for Retail Investors, and fixed-rate government bonds with maturities such as 2 years, 5 years, and 10 years are sold.
The minimum purchase amount is ¥50,000 in face value, and purchases are made in units of ¥50,000.
While the selling price of JGBs for Retail Investors is fixed at ¥100 per ¥100 of face value, the offering price of New OTC JGBs is determined based on the government bond market, auction results, and other factors at the time.
Example:
Even for a government bond with a face value of ¥100, the offering price may be ¥100, in the ¥99 range, or above ¥100.
If held until maturity, ¥100 per ¥100 of face value is generally repaid.
Differences Between JGBs for Retail Investors and New OTC JGBs
| Item | JGBs for Retail Investors | New OTC JGBs |
|---|---|---|
| Main Products | 10-Year Floating, 5-Year Fixed, 3-Year Fixed | 10-Year Fixed, 5-Year Fixed, 2-Year Fixed, etc. |
| Eligible Purchasers | Individuals | Can also be purchased by non-individuals |
| Minimum Purchase Amount | ¥10,000 | ¥50,000 |
| Purchase Unit | ¥10,000 units | ¥50,000 units |
| Offering Price | ¥100 per ¥100 of face value | Varies by issue |
| Minimum Interest Rate | Yes | No |
| Converting to Cash Before Maturity | Generally redeemed early by the government after one year has passed since issuance | Sold in the market |
| Price Fluctuation When Sold Before Maturity | Not sold at market price | Profits or losses arise depending on the market price |
| At Maturity | Redeemed at face value | Redeemed at face value |
A particularly important point is that the mechanism used when converting the bond to cash before maturity is different.
JGBs for Retail Investors are redeemed early by the government under certain conditions, while New OTC JGBs are sold in the market as ordinary bonds.
Difference Between the “Coupon Rate” and “Applicant Yield” of New OTC JGBs
When looking at New OTC JGBs, figures called the “coupon rate” and “applicant yield” are displayed.
These two are not the same.
What Is the Coupon Rate?
The coupon rate indicates how much interest is paid each year relative to the face value.
Example:
For a government bond with a face value of ¥100,000 and a coupon rate of 2%, the annual interest would be ¥2,000 before tax in a simplified calculation.
What Is the Applicant Yield?
The applicant yield indicates profitability taking into account the actual purchase price, interest received, redemption amount at maturity, and other factors.
If the purchase price of the government bond differs from its face value, the coupon rate and actual yield will differ.
Concept:
If a government bond with a face value of ¥100,000 is purchased for less than ¥100,000 and ¥100,000 is repaid at maturity, not only the interest but also the difference between the purchase price and the redemption amount becomes part of the return.
Why the Prices of New OTC JGBs Fluctuate
With New OTC JGBs and previously issued JGBs, government bond prices fluctuate in response to changes in market interest rates.
With fixed-rate bonds, market interest rates and bond prices generally tend to move in opposite directions.
- When market interest rates rise, the prices of existing fixed-rate bonds tend to fall
- When market interest rates fall, the prices of existing fixed-rate bonds tend to rise
Why Government Bond Prices Fall When Interest Rates Rise
Example:
Suppose you hold a fixed-rate government bond paying 2% per year.
Later, suppose newly issued government bonds begin offering 4% per year.
Under similar conditions, the newly issued 4% government bond provides more interest.
Therefore, to sell the existing government bond that pays only 2% in the market, the price must generally be lowered to attract buyers.
Why Government Bond Prices Rise When Interest Rates Fall
Example:
Suppose you hold a fixed-rate government bond paying 2% per year and newly issued government bonds later begin offering only 1% per year.
In this case, the existing government bond paying 2% becomes relatively more attractive.
As a result, its market price may rise above face value.
Government Bond Prices and Yields Move in Opposite Directions
An important relationship when understanding bonds is that “when prices rise, yields fall, and when prices fall, yields rise.”
Example:
Suppose there is a government bond that pays the same ¥2,000 in interest every year.
If you compare purchasing this bond for ¥100,000 with purchasing it for ¥90,000, receiving the same ¥2,000 produces a higher return relative to the amount invested when the bond is purchased for ¥90,000.
Therefore, when government bond prices fall, yields tend to rise, and when government bond prices rise, yields tend to fall.
What Are Previously Issued JGBs?
Previously issued JGBs are government bonds that have already been issued and are traded in the market.
Rather than purchasing newly offered government bonds, investors purchase government bonds that were issued in the past in the market.
Securities companies and other institutions may sell previously issued JGBs depending on the inventory they hold.
Previously issued JGBs already have established coupon rates and maturity dates, but their market prices change depending on the interest rate environment and other factors at the time.
Items to Check When Looking at Previously Issued JGBs
When examining previously issued JGBs, it is necessary to check items such as the following rather than looking only at the coupon rate.
- Face value
- Purchase price
- Coupon rate
- Interest payment dates
- Redemption date
- Remaining maturity
- Yield
How to Read the Yield of Previously Issued JGBs
With previously issued JGBs, the “yield” may be more important than the coupon rate.
The coupon rate is the percentage of interest paid relative to the face value, but the actual purchase price paid by the investor is not necessarily the same as the face value.
Example:
Suppose there is a government bond with a face value of ¥100,000 and a coupon rate of 2%.
The annual interest is ¥2,000 before tax in a simplified calculation.
If this government bond is purchased for ¥95,000 and ¥100,000 is repaid at maturity, the difference between the purchase price and redemption amount becomes part of the return in addition to the interest.
Conversely, if a government bond with a face value of ¥100,000 is purchased for ¥105,000 and redeemed for ¥100,000 at maturity, the ¥5,000 paid above face value reduces the return.
A Government Bond with a High Coupon Rate Is Not Necessarily More Advantageous
A previously issued JGB with a high coupon rate may also have a high market price.
Therefore, “the coupon rate is 3%, so the yield is also 3%” is not necessarily true.
It is necessary to check the yield while taking into account the purchase price and the period remaining until maturity.
What Is Remaining Maturity?
Remaining maturity is the period remaining from the time a government bond is purchased until its maturity date.
Example:
Even if a government bond was originally issued as a 10-year government bond, if eight years have passed since issuance, the period remaining until maturity at the time of purchase is approximately two years.
Therefore, with previously issued JGBs, it is important to check not only the original maturity of the bond but also the current remaining maturity.
Previously Issued JGBs with Short Remaining Maturities
Among previously issued JGBs, some government bonds may be sold with only several months or a few years remaining until maturity.
If you intend to hold them until maturity, they may be considered for relatively short-term asset management.
However, if the purchase price is above face value, redemption at face value at maturity will result in a loss due to the price difference.
Therefore, rather than simply assuming that a short remaining maturity makes a bond safe, it is necessary to check the purchase price and final yield.
What Are U.S. Treasury Securities?
U.S. Treasury securities are government bonds issued by the United States government.
Marketable securities issued by the U.S. Department of the Treasury include Treasury Bills, Treasury Notes, Treasury Bonds, TIPS, and Floating Rate Notes.
| Type | Main Feature |
|---|---|
| Treasury Bills | Mainly short-term securities with maturities of one year or less |
| Treasury Notes | Securities with maturities such as 2 years, 3 years, 5 years, 7 years, and 10 years |
| Treasury Bonds | Long-term securities with maturities such as 20 years and 30 years |
| TIPS | Inflation-protected securities whose principal is adjusted according to changes in prices |
| Floating Rate Notes | Securities with floating interest rates |
Investing in U.S. Treasury Securities from Japan Involves Foreign Exchange Risk
When someone who manages assets based on Japanese yen invests in U.S. Treasury securities, it is necessary to consider not only fluctuations in the price of the government bonds themselves but also fluctuations in the exchange rate between the U.S. dollar and the Japanese yen.
Example:
If you purchase $1,000 worth of U.S. Treasury securities when the exchange rate is ¥150 to the dollar, the value in Japanese yen is ¥150,000.
Even if the dollar-denominated price of the U.S. Treasury securities does not change, if the yen strengthens to ¥130 to the dollar, their value in Japanese yen becomes ¥130,000.
Conversely, if the yen weakens, the value of the assets when converted into yen may increase.
Therefore, even if the yield on U.S. Treasury securities appears higher than that of Japanese Government Bonds, when considering returns in yen, it is necessary to include the impact of foreign exchange fluctuations.
What Are STRIPS for U.S. Treasury Securities?
U.S. Treasury securities also have a system known as “STRIPS.”
With STRIPS, the interest portion and principal portion of ordinary Treasury securities are separated and traded as independent securities.
Rather than receiving periodic interest payments, some are traded by purchasing them at a price below face value and receiving a specified amount at maturity.
They may also be handled as foreign bonds by securities companies and other institutions in Japan.
What Happens If Government Bonds Are Sold Before Maturity?
The treatment of government bonds when they are converted to cash before maturity differs significantly depending on the type of bond.
In the Case of JGBs for Retail Investors
With JGBs for Retail Investors, early redemption by the government can generally be used after one year has passed since issuance.
They are not sold at market price but are redeemed early based on face value, with a specified early redemption adjustment amount deducted.
In the Case of New OTC JGBs and Previously Issued JGBs
New OTC JGBs and ordinary government bonds traded in the market can be sold in the market even before maturity.
However, the selling price will be the market price at that time.
If the price has risen since purchase, a capital gain may occur, while if the price has fallen since purchase, a capital loss may occur.
Example:
If a government bond purchased for ¥100,000 has a market price of ¥110,000 when sold, a capital gain of ¥10,000 occurs in a simplified calculation.
On the other hand, if the market price has fallen to ¥90,000 when sold, a loss of ¥10,000 occurs in a simplified calculation.
In actual transactions, accrued interest, transaction prices, taxes, financial institution transaction terms, and other factors also apply.
Difference Between Holding Until Maturity and Selling Before Maturity
With fixed-rate government bonds, even if the market price falls, the face value is generally repaid if the bond is held until maturity.
Therefore, a decline in the market price during the holding period and actually selling at that price and realizing a loss are different things.
Example:
Suppose you hold a government bond with a face value of ¥100,000 and its market price falls to ¥90,000.
If you sell it early for ¥90,000, a loss due to the price difference occurs.
On the other hand, if the issuer makes the scheduled repayment and you hold the bond until maturity, the face value of ¥100,000 is generally repaid.
However, if the government bond was purchased at a price above face value, a difference between the purchase price and the face value repaid at maturity will arise.
Government Bonds Also Have Risks
Government bonds are generally treated as highly creditworthy financial products, but they are not completely risk-free.
- Credit risk of the issuing country
- Price fluctuation risk caused by changes in market interest rates
- Possibility of loss of principal when sold before maturity
- Decline in real value due to inflation
- Opportunity loss in the case of fixed interest rates
- Foreign exchange risk in the case of foreign government bonds
Inflation and Government Bonds
With fixed-rate government bonds, even if prices rise significantly during the holding period, the interest received does not automatically increase.
Example:
If prices rise by about 4% per year while you hold a fixed-rate government bond paying 2% per year, your real purchasing power may decline even though you are receiving interest from the government bond.
Items to Check When Looking at Government Bonds
When comparing government bonds, it is important to check the following items rather than simply looking at “what percentage the interest rate is.”
- Issuing country
- Maturity
- Remaining maturity
- Whether the interest rate is fixed or floating
- Coupon rate
- Purchase price
- Yield
- Interest payment dates
- Redemption amount at maturity
- Conditions for early redemption or sale before maturity
- Currency and foreign exchange risk in the case of foreign bonds
Consider JGBs for Retail Investors Separately from Government Bonds Traded in the Market
One particularly important point when understanding government bonds is not to treat JGBs for Retail Investors and market-priced government bonds such as New OTC JGBs and previously issued JGBs as the same type of product.
| Concept | JGBs for Retail Investors | New OTC JGBs and Previously Issued JGBs |
|---|---|---|
| Purchase Price | Face value | May differ from face value |
| Market Price During Holding Period | Generally not relevant when using early redemption | Fluctuates |
| Converting to Cash Before Maturity | Redeemed early by the government under certain conditions | Sold at market price |
| Capital Gains from Price Increases | Not generally a product intended for this purpose | May occur |
| Capital Losses from Price Declines | Not sold early at market price | May occur |
Summary
Government bonds are bonds issued by governments to raise funds.
In Japan, in addition to JGBs for Retail Investors, which are easy for individuals to purchase, investors can also purchase New OTC JGBs and previously issued JGBs.
JGBs for Retail Investors are available as 3-Year Fixed, 5-Year Fixed, and 10-Year Floating products, and in principle can be redeemed early after one year has passed since issuance.
On the other hand, because the market prices of New OTC JGBs and previously issued JGBs fluctuate, selling them before maturity may result in either a capital gain or a loss of principal.
With fixed-rate government bonds, when market interest rates rise, prices generally tend to fall, while when market interest rates fall, prices generally tend to rise.
In addition, when comparing previously issued JGBs, it is important to check the “yield,” including the purchase price, remaining maturity, and redemption amount at maturity, rather than looking only at the coupon rate.
When investing in foreign government bonds such as U.S. Treasury securities, it is also necessary to consider not only the price and interest rate of the government bonds themselves but also changes in the value of the assets when converted into yen due to foreign exchange fluctuations.
When comparing government bonds, it is important not only to consider whether “the interest rate is high or low,” but also to check “at what price you purchase the bond, when it matures, and what happens if you sell it before maturity.”
References
