FAQs - Understanding Government Securities

  • What is a Government Security (G-Sec)?

    A Government Security (G-Sec) is a tradable instrument issued by the Central Government or the State Governments. It acknowledges the Government’s debt obligation. Such securities are short term (usually called treasury bills, with original maturities of less than one year) or long term (usually called Government bonds or dated securities with original maturity of one year or more). In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs). G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.

    1. Treasury Bills (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 presently 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 Rs.100/- (face value) may be issued at say Rs.98.20, that is, at a discount of say, Rs.1.80 and would be redeemed at the face value of Rs.100/-. The return to the investors is the difference between the maturity value or the face value (that is Rs.100) and the issue price.
    2. Cash Management Bills (CMBs): The Government of India, also issues a new short-term instrument, known as Cash Management Bills (CMBs), to meet the temporary mismatches in the cash flow of the Government of India. The CMBs have the generic character of T- bills but are issued for maturities less than 91 days.
    3. Dated G-Secs: Dated G-Secs are securities which carry a fixed or floating coupon (interest rate) which is paid on the face value, on half-yearly basis. Generally, the tenor of dated securities ranges from 5 years to 40 years.
      1. Fixed Rate Bonds – These are bonds on which the coupon rate is fixed for the entire life (i.e. till maturity) of the bond. Most Government bonds in India are issued as fixed rate bonds. For example – 5.77% GS 2030 was issued on August 03, 2020 for a tenor of 10 years maturing on August 03, 2030. Coupon on this security will be paid half-yearly on the face value on February 03 and August 03 of each year.
      2. Floating Rate Bonds (FRB) – FRBs are securities which do not have a fixed coupon rate. Instead it has a variable coupon rate which is re-set at pre-announced intervals (say, every six months or one year).
      3. Capital Indexed Bonds – These are bonds, the principal of which is linked to an accepted index of inflation with a view to protecting the Principal amount of the investors from inflation. A 5 year Capital Indexed Bond, was first issued in December 1997 which matured in 2002.
      4. Inflation Indexed Bonds (IIBs) - IIBs are bonds wherein both coupon flows and Principal amounts are protected against inflation. The inflation index used in IIBs may be Whole Sale Price Index (WPI) or Consumer Price Index (CPI). Government of India in consultation with RBI issued the IIBs (CPI based) exclusively for the retail customers in December 2013.
      5. STRIPS – Separate Trading of Registered Interest and Principal of Securities - STRIPS are the securities created by way of separating the cash flows associated with a regular G-Sec i.e. each semi-annual coupon payment and the final principal payment to be received from the issuer, into separate securities. They are essentially Zero Coupon Bonds (ZCBs). Stripped securities represent future cash flows (periodic interest and principal repayment) of an underlying coupon bearing bond. STRIPS have zero reinvestment risk, being zero coupon bonds, they can be attractive to retail/non-institutional investors.
      6. Sovereign Gold Bond (SGB)- SGBs are unique instruments, prices of which are linked to commodity price viz Gold. SGBs are also budgeted in lieu of market borrowing. The calendar of issuance is published indicating tranche description, date of subscription and date of issuance. The Bonds shall be denominated in units of one gram of gold and multiples thereof. The Bonds shall be repayable on the expiration of eight years from the date of issue of the Bonds. Pre-mature redemption of the Bond is permitted after fifth year of the date of issue of the Bonds and such repayments shall be made on the next interest payment date. The bonds under SGB Scheme may be held by a person resident in India, being an individual, in his capacity as an individual, or on behalf of minor child, or jointly with any other individual. The bonds may also be held by a Trust, HUFs, Charitable Institution and University. The Bonds shall bear interest at the rate of 2.50 percent (fixed rate) per annum on the nominal value. Interest shall be paid in half-yearly rests and the last interest shall be payable on maturity along with the principal.
      7. State Development Loans (SDLs): State Governments also raise loans from the market which are called SDLs. Interest is serviced at half-yearly intervals and the principal is repaid on the maturity date.

      Please refer to RBI Circulars and Notifications on the instrument types.

  • Why should one invest in G-Secs?

    Holding of cash in excess of the day-to-day needs (idle funds) does not give any return. Investing in G-Secs has the following advantages:

    • Besides providing a return in the form of coupons (interest), G-Secs offer the maximum safety as they carry the Sovereign’s commitment for payment of interest and repayment of principal.
    • They can be held in book entry, i.e., dematerialized/ scripless form, thus, obviating the need for safekeeping. They can also be held in physical form.
    • G-Secs are available in a wide range of maturities from 91 days to as long as 40 years to suit the duration of varied liability structure of various institutions.
    • G-Secs can be sold easily in the secondary market to meet cash requirements.
    • Securities such as State Development Loans (SDLs) provide attractive yields.
    • 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.
    • G-Sec prices are readily available due to a liquid and active secondary market and a transparent price dissemination mechanism.

  • How and in what form can G-Secs be held?

    The Public Debt Office (PDO) of RBI, acts as the registry and central depository for G- Secs. They may be held by investors either as physical stock or in dematerialized (demat/electronic) form

    1. Physical form: G-Secs may be held in the form of stock certificates. A stock certificate is registered in the books of PDO. Ownership in stock certificates cannot be transferred by way of endorsement and delivery. They are transferred by executing a transfer form as the ownership and transfer details are recorded in the books of PDO. The transfer of a stock certificate is final and valid only when the same is registered in the books of PDO.
    2. Demat form: Holding G-Secs in the electronic or scripless form is the safest and the most convenient alternative as it eliminates the problems relating to their custody, viz., loss of security. Besides, transfers and servicing of securities in electronic form is hassle free. The holders can maintain their securities in dematerialsed form by opening a Retail Direct Gilt Account with RBI.

      The servicing of securities held in the Gilt Accounts is done electronically, facilitating hassle free trading and maintenance of the securities. Receipt of maturity proceeds and periodic interest is also faster as the proceeds are credited to the registered bank account of the Gilt Account Holders (GAH).

  • How does the trading in G-Secs take place?

    There is an active secondary market in G-Secs. The securities can be bought / sold in the secondary market either through

    1. Negotiated Dealing System-Order Matching (NDS- OM) (anonymous online trading) or through
    2. Over the Counter (OTC) voice market.
    Please refer to the NDS OM section for details on how to trade on NDS OM.

  • What are the important considerations while undertaking security transactions?

    The following steps should be followed in purchase of a security:

    1. Which security to invest in – Typically this involves deciding on the maturity and coupon. Maturity is important because this determines the extent of risk an investor is exposed to – normally higher the maturity, higher the interest rate risk or market risk. Within the shorter maturity range (say 5-10 years), it would be safer to buy securities which are liquid, that is, securities which trade in relatively larger volumes in the market. Pricing is more transparent in liquid securities, thereby reducing the chances of being misled/misinformed. The coupon rate of the security is equally important for the investor as it affects the total return from the security. In order to determine which security to buy, the investor must look at the Yield to Maturity (YTM) of a security. Thus, once the maturity and yield (YTM) is decided, the investor may select a security by looking at the price/yield information of securities traded on NDS-OM.
    2. Where and Whom to buy from- In terms of transparent pricing, the NDS-OM is the safest because it is a live and anonymous platform where the trades are disseminated as they are struck and where counterparties to the trades are not revealed. In case, the trades are conducted on the telephone market, it would be safe to trade directly with a bank or a PD other than a bank, PD or a financial institution, to minimize the risk of getting adverse prices.
    3. How to ensure correct pricing – Since investors have very small requirements, they may get a quote/price, which is worse than the price for standard market lots. To be sure of prices, only liquid securities may be chosen for purchase. It is important to the check the current prices of the security on NDS OM before arriving at the price for a security.

  • How does one get information about the price of a G-Sec?

    Price information is vital to any investor intending to either buy or sell G-Secs. Information on traded prices of securities is available on the RBI website under the path Home → Financial Markets → Financial Markets Watch → Order Matching Segment of Negotiated Dealing System. This will show a screen containing the details of the latest trades undertaken in the market along with the prices. Additionally, trade information can also be seen on CCIL website. On this page, the list of securities and the summary of trades is displayed. The total traded amount (TTA) on that day is shown against each security. Typically, liquid securities are those with the largest amount of TTA. Pricing in these securities is efficient and hence Investors can choose these securities for their transactions. Participants can thus get near real-time information on traded prices and take informed decisions while buying / selling G-Secs. The screenshots of the above webpage are given below:

    NDS-OM Market

    government security
  • Why does the price of G-Sec change?

    The price of a G-Sec, like other financial instruments, keeps fluctuating in the secondary market. The price is determined by demand and supply of the securities. Specifically, the prices of G-Secs are influenced by the level and changes in interest rates in the economy and other macro-economic factors, such as, expected rate of inflation, liquidity in the market, etc. Developments in other markets like money, foreign exchange, credit, commodity and capital markets also affect the price of the G-Secs. Further, developments in international bond markets, specifically the US Treasuries affect prices of G-Secs in India. Policy actions by RBI (e.g., announcements regarding changes in policy interest rates like Repo Rate, Cash Reserve Ratio, Open Market Operations, etc.) also affect the prices of G-Secs.

  • How is the Price of a bond calculated? What is the total consideration amount of a trade and what is accrued interest?

    The price of a bond is nothing but the sum of present value of all future cash flows of the bond. The interest rate used for discounting the cash flows is the Yield to Maturity (YTM) of the bond. Price can be calculated using the excel function ‘Price’. Accrued interest is the interest calculated for the broken period from the last coupon day till a day prior to the settlement date of the trade. Since the seller of the security is holding the security for the period up to the day prior to the settlement date of the trade, she is entitled to receive the coupon for the period held. During settlement of the trade, the buyer of security will pay the accrued interest in addition to the agreed price and pays the ‘consideration amount’. An illustration is given below; For a trade of Rs.5 crore (face value) of security 8.83% 2023 for settlement date Jan 30, 2014 at a price of Rs.100.50, the consideration amount payable to the seller of the security is worked outbelow: Here the price quoted is called ‘clean price’ as the ‘accrued interest’ component is not added to it. Accrued interest: The last coupon date being Nov 25, 2013, the number of days in broken period till Jan 29, 2014 (one day prior to settlement date i.e. on trade day) are 65. The accrued interest on ₹ 100 face value for 65 days = 8.83 x(65/360) =₹ 1.5943 When we add the accrued interest component to the ‘clean price’, the resultant price is called the ‘dirty price’. In the instant case, it is 100.50+1.5943 = ₹ 102.0943. The total consideration amount = Face value of trade x dirty price = 5,00,00,000 x (102.0943/100) = ₹ 5,10,47,150/-

  • What is the relationship between yield and price of a bond?

    If market interest rate levels rise, the price of a bond falls. Conversely, if interest rates or market yields decline, the price of the bond rises. In other words, the yield of a bond is inversely related to its price. The relationship between yield to maturity and coupon rate of bond may be stated as follows:

    • When the market price of the bond is less than the face value, i.e., the bond sells at a discount, YTM >> coupon yield.
    • When the market price of the bond is more than its face value, i.e., the bond sells at a premium, coupon yield >>YTM.
    • When the market price of the bond is equal to its face value, i.e., the bond sells at par, YTM = coupon yield.

  • How is the yield of a bond calculated?

    An investor who purchases a bond can expect to receive a return from one or more of the following sources:

    • The coupon interest payments made by the issuer;
    • Any capital gain (or capital loss) when the bond is sold/matured; and
    • Income from reinvestment of the interest payments that is interest-on-interest.
    The three yield measures commonly used by investors to measure the potential return from investing in a bond are briefly described below:

    1. Coupon Yield: The coupon yield is simply the coupon payment as a percentage of the face value. Coupon yield refers to nominal interest payable on a fixed income security like G-Sec. This is the fixed return the Government (i.e.,theissuer) commits to pay to the investor. Coupon yield thus does not reflect the impact of interest rate movement and inflation on the nominal interest that the Government pays. Coupon yield = Coupon Payment / Face Value Illustration: Coupon: 8.24 Face Value: ₹100 Market Value: ₹103.00 Coupon yield = 8.24/100 = 8.24%
    2. Current Yield: The current yield is simply the coupon payment as a percentage of the bond’s purchase price; in other words, it is the return a holder of the bond gets against its purchase price which may be more or less than the face value or the par value. The current yield does not take into account the reinvestment of the interest income received periodically. Current yield = (Annual coupon rate / Purchase price) X 100 Illustration: The current yield for a 10 year 8.24% coupon bond selling for ₹103.00 per ₹100 par value is calculated below: Annual coupon interest = 8.24% x ₹100 = ₹8.24 Current yield = (8.24/103) X 100 = 8.00% The current yield considers only the coupon interest and ignores other sources of return that will affect an investor’s return.
    3. Yield to Maturity: Yield to Maturity (YTM) is the expected rate of return on a bond if it is held until its maturity. The price of a bond is simply the sum of the present values of all its remaining cash flows. Present value is calculated by discounting each cash flow at a rate; this rate is the YTM. Thus, YTM is the discount rate which equates the present value of the future cash flows from a bond to its current market price. In other words, it is the internal rate of return on the bond. The calculation of YTM involves a trial-and-error procedure. A calculator or software can be used to obtain a bond’s YTM easily.

  • How is the yield of a T- Bill calculated?

    It is calculated as per the following formula

    Wherein; P=Purchase Price, D= Days to Maturity Day Count: For T- Bills, = [actual number of days to maturity/365]

    Illustration: Assuming that the price of a 91 day T-- bill at issue is ₹98.20, the yield on the same would be

    After say, 41 days, if the same T- bill is trading at a price of ₹99, the yield would then be Yield

    Note that the remaining maturity of the T-Bill is 50 days (91-41).

  • What are the risks involved in holding G-Secs? What are the techniques for mitigating such risks?

    G-Secs are generally referred to as risk free instruments as sovereigns rarely default on their payments. However, as is the case with any financial instrument, there are risks associated with holding the G-Secs. Hence, it is important to identify and understand such risks and take appropriate measures for mitigation of the same. The following are the major risks associated with holding G-Secs:

    1. Market risk – Market risk arises out of adverse movement of prices of the securities due to changes in interest rates. This will result in valuation losses on marking to market or realizing a loss if the securities are sold at adverse prices. Small investors, to some extent, can mitigate market risk by holding the bonds till maturity so that they can realize the yield at which the securities were actually bought.
    2. Reinvestment risk – Cash flows on a G-Sec includes a coupon every half year and repayment of principal at maturity. These cash flows need to be reinvested whenever they are paid. Hence there is a risk that the investor may not be able to reinvest these proceeds at yield prevalent at the time of making investment due to decrease in interest rates prevailing at the time of receipt of cash flows by investors.
    3. Liquidity risk – Liquidity in G-Secs is referred to as the ease with which security can be bought and sold i.e. availability of buy-sell quotes with narrow spreads. Liquidity risk refers to the inability of an investor to liquidate (sell) his holdings due to non-availability of buyers for the security, i.e., no trading activity in that particular security or circumstances resulting in distressed sale (selling at a much lower price than its holding cost) causing loss to the seller.
    4. Risk Mitigation- Holding securities till maturity could be a strategy through which one could avoid market risk. Rebalancing the portfolio wherein the securities are sold once they become short term and new securities of longer tenor are bought could be followed to manage the portfolio risk. However, rebalancing involves transaction and other costs and hence needs to be used judiciously.

    Source: Reserve Bank of India: Government Securities Market: A Primer.