Government Bonds: Bunds, Treasuries and Euro-Area Spreads

What you will learn

• The German federal securities segments (Bubill, Schatz, Bobl, Bund) and their US Treasury counterparts.
• How to compare yields quoted with annual and semi-annual coupons.
• What drives euro-area government bond spreads, such as the Italy–Germany spread.
• How to estimate the price effect of a spread change with duration.

Explanation

German federal securities

German government debt is issued for the federal government by the Bundesrepublik Deutschland – Finanzagentur GmbH (the German Finance Agency), mainly through auctions to a group of banks. Private investors buy afterwards on the secondary market through a bank or broker, usually via an exchange. According to the Finance Agency, the main segments are:

There are also green federal securities, "twins" of conventional bonds with the same coupon and maturity, whose proceeds are linked to eligible green expenditure. Inflation-linked federal bonds are covered in lesson 7. The issuance calendar and the segments can change, so check the Finance Agency's current information.

Bunds serve as the main benchmark (reference yield) for the euro area: other euro government and corporate bonds are often quoted as a spread over Bunds of similar maturity. The most recently issued bond of each maturity is usually the most traded (called "on-the-run"); older issues can trade at slightly different yields.

US Treasuries

The US Treasury issues bills (up to 52 weeks, discount paper), notes (2, 3, 5, 7 and 10 years) and bonds (20 and 30 years). Notes and bonds pay coupons semi-annually. For a euro investor, Treasuries add US dollar exchange-rate risk; lesson 12 covers this.

Because of the different coupon frequency, quoted yields are not directly comparable. A US yield quoted on a semi-annual basis is converted to an annual-equivalent yield with:

Annual-equivalent yield = (1 + y/2)² − 1

Euro-area spreads

All euro-area governments borrow in euros, but they do not borrow at the same yield. The difference to the Bund yield of the same maturity is the sovereign spread, for example the BTP–Bund spread (BTP: Buoni del Tesoro Poliennali, Italian government bonds) or the OAT–Bund spread (OAT: Obligations assimilables du Trésor, French government bonds). Main drivers:

• Credit risk: debt levels, deficits, growth and political stability. Euro-area countries cannot print their own currency, so their debt carries some default risk.
• Liquidity: how easily large amounts can be traded.
• Safe-haven demand: in stress, investors buy Bunds, pushing Bund yields down and spreads up.
• Redenomination risk: the fear that a country could leave the euro. The euro crisis is covered in the course "Market History: Bubbles, Crashes & Lessons".
• Central-bank policy: in 2022 the European Central Bank (ECB) created the Transmission Protection Instrument (TPI), which allows it to buy bonds of a country facing disorderly market moves that are not justified by fundamentals, subject to conditions. Its existence can influence spreads, but it does not remove credit risk.

Spread risk is measured with the same duration logic as rate risk: a bond's price falls by roughly duration × spread change.

Worked example

Hypothetical example: a 10-year Bund yields 2.6% and a 10-year Italian BTP yields 3.8%. You hold €10,000 of the BTP; its modified duration is 8.2. Fees, spreads between bid and ask, and taxes are excluded.

1. Spread. 3.8% − 2.6% = 1.2 points = 120 bp.

2. Spread widening. The Bund yield stays at 2.6%, but the spread widens by 50 bp to 170 bp, so the BTP yield rises to 4.3%.

Price change ≈ −8.2 × 0.005 = −4.1%. On €10,000: −€410.

3. Comparing with a Treasury. A US 10-year note yields 4.0% on a semi-annual basis. Annual-equivalent = (1 + 0.04/2)² − 1 = 1.02² − 1 = 4.04%. The extra 0.04 points matter when comparing with annual-coupon Bunds, but the bigger difference for a euro investor is currency risk, which is not included here.

Yield pickup over the Bund (1.2 points a year) can be wiped out by a spread widening of about 1.2 ÷ 8.2 ≈ 0.15 points, i.e. 15 bp, within one year.

Common mistake

Practice activity

On paper, with hypothetical data: a 5-year French OAT yields 2.9% and the 5-year Bobl yields 2.3%. The OAT has a modified duration of 4.6. (a) Calculate the spread in bp. (b) Estimate the price change on €5,000 if the spread narrows by 20 bp while the Bobl yield is unchanged. (c) Convert a semi-annual US yield of 3.6% to an annual-equivalent yield.

Key takeaways

• German federal securities run from Bubills (up to 1 year) through Schatz, Bobl and Bund (up to 30 years), with annual coupons.
• US notes and bonds pay semi-annually; convert yields before comparing.
• Euro-area spreads reflect credit, liquidity, safe-haven flows and central-bank policy.
• Spread risk ≈ duration × spread change; a small widening can cancel a yield advantage.

Next step

In the next lesson you will move from governments to companies and learn how credit ratings, spreads and default risk fit together.