So government bonds. Government bonds are a source of funding for the government. Every year the government has a huge budget, loads of costs for the government in every individual year. How does it finance tha budget? Well, the primary financing, hopefully in any case, is taxation. That's the blue box here. So those are just the usual tax payments made from citizens of the country, people that live in the country, corporates, and everyone else that's paying taxes in the country. The red boxes though, are another form of financing for the government. The first one is issuance of currency. The government can just issue currency. What happens if it issues currency? Is that an interest payable liability? Well, of course it's not. It's never happened to me in any case that I put a bank note in my pocket and the value of that bank note has grown in that time. So the issuance of currency is an interest free debt. And then of course we have the issuance of bonds. That's when the government issues bonds in return for cash in order to finance the budget. So really what's happening here again, is the government issues. These bonds, that's the upper area you can see on the screen here, and those bonds will go out to investors, individuals, corporates, asset managers, anyone else really interested in buying these government bonds. What happens in return, of course, is that the government gets cash from these investors and all of a sudden it has more money to fund its ongoing budget.

A couple of terminology points here for you. The nominal interest rate. The nominal interest rate is just when we say the interest rate, we typically tend to think of the nominal interest rates, and it's usually the yield of a bond. What about the real interest rate? Well, the real interest rate is looking at that nominal interest rate and comparing it to the inflation. So if the nominal interest rate is higher than inflation, then of course we have more money in our pocket adjusted for purchasing power after our investment. So the real interest rate is really just the nominal interest rate minus inflation.

And finally, the effective interest rate. Well usually the nominal interest rate and the effective interest rate is the same if the payment of the interest is once per annum. However, if you have a quoted interest payable more often than once a year, or a more frequent compounding than the effective interest rate will be higher than a nominal interest rate due to the interest on interest effect.