Question

31. Explain why U.S. Government bonds are default risk free while Greece Government bonds are not default risk free.

Answer 1

The risks associated with a bond are generally default risk, interest rate risk and currency risk (depending on the currency of bond issuance).Here the default risk is the risk that the issuer of bond will default on its commitment of paying the promised bond maturity and coupon payments as per the promised schedule. A government issued bonds are generally considered low risk as the default risk associated with a bond is is generally less for sovereign bonds (assumed that governments will honour their commitments and repau on time). But sovereign risk has in the recent times become a volatile risk in itself. When countries like US has been able to repay their commitments and not defaulted, countries like Greece have defaulted on their commitments making their default risk high. Thus US government is considered as default risk free as the trust that US government will honour its commitments is high. While for Greece, due to the recent economic turmoil and the history of default, the default risk is high.