What are Government bonds?

Government bonds more popularly known as government securities (g-secs) are issued by the state government or the central governments. When you invest in a government bond, it means you are a creditor loaning money to the government. Such kinds of bonds are typically issued when the government needs funds for infrastructure development. In this article, we will take a detailed look at government bonds and the advantages and disadvantages of investing in them, as well as the inherent risks involved in the securities market.

How do G-sec bonds function?

In India, the government issues both T-bills (treasury bills) and government bonds, while the bonds issued by state governments are called the State Development Loans (SDLs).

Treasury bills are g-sec bonds which have a maturity of less than one year. T-bills have a maturity period of 91 days, 182 days and 365 days, while G secs are a long term investment option issued for periods between 5 to 40 years.

How does an investor invest in G-secs?

The government issues t-bills and government bonds through auction. The auction dates and the bond sales date are announced ahead of time along with which it also discloses the amount of securities it will issue. There are two processes which are applied for auctions i.e yield-based and price -based. In a yield-based auction, new G-Secs are sold while, in a price-based auction, the government reissues securities issued earlier.

Benefits and drawbacks of investing in Government Bonds?

In the Indian bonds market, there are two kinds of bonds on which investors can invest in- government bonds (G-secs) and corporate bonds - bonds issued by companies. Up until a few years ago, g-sec bonds were a viable investment option for financial institutions, banks and corporate bodies. However, g-sec bonds are now a very rewarding bet for individual investors.

Advantages of investing in a Government bond

Low Risk: Government bonds are deemed to be highly secure and are termed as a low-risk investment. G-secs are the best option for investors looking for low risk investment as they are backed by the Indian government which means guaranteed coupon payments and the return of your principal investment upon maturity.

Regular Income: As interest earned on government bonds (in case of non-zero coupon bonds) is disbursed quarterly, semi-annually or annually to debt holders, investing in government bonds provides investors with the opportunity to earn regular income.

Liquidity: Just like equities, government bonds can also be bought and sold in the secondary market. Liquidity in government bonds is improving as banks and financial institutions regularly participate in the bond market.

Diversify portfolio: Government bonds are a great way to diversify investment portfolios as government bonds are backed by the Indian government and they help in mitigating the risk.

Collateral for loans: government bonds can be used as collateral against short-term loans and What are the various types of bonds available in India?to borrow funds in the repo market.

Ease of settlement: The settlement system for trading in G-Secs, which is based on Delivery versus Payment (DvP), is a very simple, safe and efficient system of settlement. The DvP mechanism ensures transfer of securities by the seller of securities simultaneously with transfer of funds from the buyer of the securities, thereby mitigating the settlement risk.

Disadvantages of investing in a Government bonds

a) The long term returns on government bonds are lower compared to other kinds of securities

b) During a period of high inflation, government bonds may lose value as high inflation may erode the coupon earnings.

Types of Government Bonds

T-Bills: Treasury bills or T-bills, which are money market instruments, are short term debt instruments issued by the Government of India and are issued in three tenors, namely, 91 day, 182 day and 364 day. Treasury bills are zero coupon securities and pay no interest. Instead, they are issued at a discount and redeemed at the face value at maturity. For example, a 91 day Treasury bill of ₹100/- (face value) may be issued at say ₹ 98.20, that is, at a discount of say, ₹1.80 and would be redeemed at the face value of ₹100/-. The return to the investors is the difference between the maturity value or the face value (that is ₹100) and the issue price.

Cash Management Bills: These are typically issued by the central government to meet its immediate cash requirements. They are short term bills issued by the RBI on behalf of the government. The RBI states that cash management bills are non-standard, discounted instruments issued for maturities less than 91 days. The Government of India typically issues the short-term instrument, known as Cash Management Bills, to meet their temporary cash flow mismatches. The Cash Management Bills are a non-standard, discounted instruments issued for maturities of less than 91 days. The Cash Management Bills have the generic character of Treasury Bills and their sale is subject to the terms and conditions specified in the General Notification No. F.2 (12)-W&M/97 dated 31st March 1998 issued by Government of India and as amended from time to time.

The Cash Management Bills have the following features.

a) The tenure, notified amount and date of issue of the proposed Cash Management Bills depends upon the temporary cash requirement of the Government. However, the tenure of the proposed Bills is less than 91 days.

b) The proposed Bills are issued at discount to the face value through auctions, as in the case of the Treasury Bills.

c) The announcement of the auction of the proposed Bills is made by the Reserve Bank of India through separate Press Release to be issued one day prior to the date of auction.

d) The settlement of the auction is on T+1 basis.

e) The Non-Competitive Bidding Scheme for Treasury Bills isn’t extended to the Cash Management Bills.

f) The proposed Bills are tradable and qualify for ready forward facility. Investment in the proposed Bills will be reckoned as an eligible investment in Government Securities by banks for SLR purpose under Section 24 of the Banking Regulation Act, 1949.

Dated Government Securities: These are long term bonds issued by the government and have a fixed or a floating interest rate. The name dated securities is because of the date of the maturity mentioned against them. The tenure of dated securities could be between 5 to 40 years years.. Fixed and floating rate bonds, zero-coupon bonds, capital index bonds, bonds with a call or a put option are examples of dated government securities.

In case, there are two securities with the same coupon and are maturing in the same year, then one of the securities will have the month attached as suffix in the nomenclature. eg. 6.05% GS 2019 FEB, would mean that G-Sec having coupon 6.05% that mature in February 2019 along with the other similar security having the same coupon. In this case, there is another paper viz. 6.05%GS2019 which bears same coupon rate and is also maturing in 2019 but in the month of June. Each security is assigned a unique number called ISIN (International Security Identification Number) at the time of issuance itself to avoid any misunderstanding among the traders.

If the coupon payment date falls on a Sunday or any other holiday, the coupon payment is made on the next working day. However, if the maturity date falls on a Sunday or a holiday, the redemption proceeds are paid on the previous working day.

State Development Loans (SDLs) : State Governments also raise loans from the market which are called SDLs. SDLs are dated securities issued through normal auction similar to the auctions conducted for dated securities issued by the Central Government. Interest is serviced at half-yearly intervals and the principal is repaid on the maturity date.

Who can invest in Government bonds?

Government bonds are known as the most secure type of bond due to its sovereign guarantee. Therefore making it a perfect investment choice for investors who are risk-averse and prefer investments without the uncertainty of price fluctuations in other markets. Individuals who want to diversify their risk factor can also have government bonds in their portfolios. Investors can purchase G-sec’s directly from the exchange via their broker willing to offer the bonds for sale. Investors can also invest in bonds via mutual funds route to mitigate the liquidity risk.