Which factors affect the prices of government bonds?
Supply and demand
Just like any financial asset, government bond prices are dictated by supply and demand. The supply of government bonds is set by each government, who’ll issue new bonds as and when they are needed. Demand for bonds is dependent on whether the bond looks like an attractive investment.
Interest rates can have a major impact on the demand for bonds. If interest rates are lower than the coupon rate on a bond, demand for that bond will rise as it represents a better investment. But if interest rates rise above the coupon rate of the bond, demand will drop.
How close the bond is to maturity
Newly-issued government bonds will always be priced with current interest rates in mind, meaning that they’ll usually trade at or near their par value. And by the time a bond has reached maturity, it’s just a pay out of the original loan – meaning that a bond will move back towards its par value as it nears this point.
The number of interest rate payments remaining before a bond matures will also have an impact on its price.
Government bonds are usually viewed as low-risk investments, because the likelihood of a government defaulting on its loan payment tends to be low. But defaults can still happen, and a riskier bond will usually trade at a lower price than a bond with lower risk and a similar interest rate.
The main way of assessing the risk of a government defaulting is through its rating from the three main credit rating agencies – Standard and Poor’s, Moody’s and Fitch.