Government bonds: Are they actually as boring as they sound, or a great deal to seal? A tradable security issued by the government is known as Government security or G-Sec. These could be in the form of treasury bills, having a short time maturity of less than a year, or government bonds, having a long term maturity of more than a year.
A bond is a financial (debt) instrument that represents a loan taken by either a corporate body or the government from an individual. The bond is issued for a definite period of time, usually long term and interest also called as coupon rate, is paid on regular intervals.
What are Government Bonds?
Government bonds are those issued by the central or state government, usually to large investors such as companies, commercial banks, but also to individual investors and co-operatives. These bonds are issued usually when the government is in need of huge funds for infrastructural development or other day-to-day operations.
To ensure the efficient transaction of securities, stock exchanges have various clearing agencies. These clearing agencies help transfer the funds to the seller and the securities to the buyer. Clearing Corporation of India Limited (CCIL) is the clearing agency for the Government securities.
Why government securities?
Investing in government securities has a lot of benefits. It is practically the safest investment option. They are issued in varying maturity periods starting from 91 day to 40 years. The investor is free to choose as per their preference. They can be used as collateral to borrow funds in the repo market.
What are Open market operations?
Though the securities are issued by the government, in fact, they are issued by the Reserve Bank of India (RBI) on behalf of the government. When RBI observes an inflation rise in the economy, it will sell government bonds and other G-securities to reduce the money supply. Conversely, it buys back, also known as repurchase, the bonds to increase the money supply, if required.
Who are the major players in the government bonds market?
Prime players include commercial banks, primary dealers and institutional investors. Other participants in the government bonds market are regional rural banks, co-operative banks, mutual funds, pension and provident funds. Foreign Portfolio Investors (FPI) are also allowed to invest in the government bonds market but within the quantitative limits prescribed from time to time. Corporates also buy/ sell the G-bonds to manage their overall portfolio.
What are the various types of government bonds?
1. Fixed-rate bonds
As the name suggests, the coupon rate on these bonds are fixed for the entire tenure of the bond. For instance, if a bond with a coupon rate of 10% is issued for 10 years, semi-annual interest of 5% will be paid till the bond matures. Most of the government bonds issued in India are fixed-rate bonds.
2. Floating rate bonds
Unlike fixed-rate bonds, floating-rate bonds are sensitive to the fluctuations in the market prices of bonds. The coupon rate is adjusted at pre-announced intervals, which are either yearly or half-yearly. There is another type of floating-rate bonds in which the coupon consists of a base rate plus a fixed spread which is determined by means of an auction.
3. Inflation indexed bonds
This is a special type of bond issued by the government of India to protect the investors against inflation. Both principal amount and coupon rate are adjusted with a price index. The index used could be the Wholesale Price Index (WPI) or Consumer Price Index (CPI). Inflation indexed bond linked to wholesale price index was issued by RBI on behalf of the Government of India in June 2013.
4. Capital indexed bonds
This is a type of inflation-indexed bond. Here, only the principal amount of the bond is revised by adjusting to an accepted inflation index. Capital indexed bonds are usually issued for longer periods. The first capital indexed bond holding a maturity period of 5 years was issued in December 1997.
5. Special securities
Special securities are issued by the government to companies like Fertilizer Companies, FCI, Oil Marketing Companies etc., as compensation instead of cash subsidies. These securities usually are long-dated securities having a higher coupon compared to other similar securities. For raising funds, the companies are free to sell these securities in the secondary market.
6. Bonds with call/put option
In this type of bond, there is an option for put only, call only, or both. Here, the investor would have an option to sell the bond(put option) and/or the issuer of the bond is given the option to buy back(call option) during the tenure of the bond. However, this option can be exercised only after the completion of 5 years from the date of issuance of the bond.
STRIPS expand to Separate Trading of Registered Interest and Principal of Securities. This is a special type of zero-coupon bond wherein, a single bond is bifurcated into multiple securities. Each coupon cash flow is treated as a separate STRIP, and the principal payment is also considered as a STRIP. These are eventually traded in the secondary market. These STRIPs are created out of existing bonds only.
8. Sovereign gold bonds
The price of this type of bond is linked to the commodity price of Gold. The Bonds are denominated in units of one gram of Gold and multiples thereof. This bond may be held by an Indian resident, a Trust, HUFs, Charitable Institution and University. The Bonds are repayable only on the expiration of eight years from the date of issue of the Bonds. The interest rate on such bonds is fixed at 2.5%p.a on the nominal value of the bond.
9. 7.75% Savings (Taxable) Bonds, 2018
7.75% Savings (Taxable) Bonds,2018 were issued by the Government of India with effect from 10-01-2018. The interest earned by the investor on these bonds attract Income tax but do not attract Wealth Tax. These bonds are issued only at par, for the face value of Rs.1,000 and multiples thereof.
10. State development loans
State governments issue bonds in the form of State development loans. These are also issued through an auction process. The coupon is paid half-yearly and principal paid at maturity.
Government bonds could sometimes be a tricky investment option. Though they are advantageous, there are also certain drawbacks to these bonds. The interest rates could be so low that it is not in a position to compete with the rising inflation.
Anyway, just like it’s advisable for any other investment avenue, the government bonds must also be properly analyzed. Invest in an asset only after you know what all risks are associated with it and whether it suits your risk profile and investment objectives or not.
So, do you have government bonds in your portfolio? Let us know in the comments below.