Government Securities (G-Sec) Bonds: A Safe Avenue for Wealth protection

PentadalAuthors: Sujal Modi, Nikhil Pal, Pravin Narkhede, Chetan Shah , Vivek Patel

What are Government Bonds?

A government bond is a debt instrument issued by the central and state government of
the country to finance their needs and also to regulate the money supply. When the
government requires funds for infrastructure development and for financing government
spending such bonds are often the answer. Thus, the government will sell bonds to the public,
inviting investments. The government will pay back the principal and interest as per the
clauses mentioned in the bond at the specified maturity date. The government
issues bonds under the supervision of the Reserve Bank of India (RBI).
The RBI issues bonds on behalf of the government of India to finance the fiscal deficit. Over
the past few years, the bonds were issued to large market participants like companies,
commercial banks and financial institutions. However, in recent years, government bonds
have been available to smaller investors like individual investors, co-operative banks etc.
Also, individual investors are taking a lot of interest in investing in government bonds.
Generally, Government bonds in India are long term investment tools. These bonds are for a
long duration ranging from 5 years to 40 years. Also, government bonds fall under the broad
category of government securities (G-secs). Both the central and state government can issue
government bonds. However, the bonds issued by state governments are also called State
Development Loans(SDLs).

Types of Government Bonds

The following are the different types of Government Bonds.
1. Treasury Bills
Treasury bills, also known as T-bills, are short term government bonds. They are issued for
maturity within one year. The government issues these bonds in three categories, i.e. 91 days,
182 days and 364 days. The investors do not get coupon payments. However, the difference
between the face value and the discounted value is the profit for the investors.
 2. Dated Government Securities
This type of bond comes with varying rates of interest. The investors will benefit from the
interest paid on these bonds. Dated Government securities are termed “dated” owing to the
element of the predetermined maturity date. The Reserve Bank of India auctions these bonds.
The following are types of dated government securities.
A. Fixed-Rate Bonds
Government bonds of this nature have a fixed coupon rate throughout the tenure of the bond.
In other words, the interest rate remains constant for the entire investment tenure irrespective
of the fluctuating market rates.

B. Floating Rate Bonds

C. Zero Coupon Bonds
D. Capital Index Bonds
E. Inflation Indexed Bonds
F. Bonds with Call or Put Option
G. Special Securities
H. STRIPS :STRIPS means Separate Trading of Registered Interest and Principal of
Securities. Here, each cash flow of a fixed rate bond is converted into individual
security. Next, they are traded in the secondary market. Also, they are very similar
to zero coupon bonds. However, they are created out of the existing securities.

3. Cash Management Bills

4. Sovereign Gold Bonds (SGBs)
5. 7.75% GOI Savings Bond

Coupon rate

 It is fixed annual rate at which bonds pays its holder or owner. It is based on face
value of the bond at the time of issue. Generally described as percentage per year.
 It is also known as, nominal rate, nominal yield or coupon payment.
  The coupon rate is calculated on the bond’s face value (or par value/ true value/
principal ), not on the issue price or market value.

Coupon Rate (%) = (Total annual payment / Face value of bond) * 100

Coupon Rate Vs Interest rate

 Coupon rate is fixed while interest rate changes on which price u bought the bond
(Discount / Premium)
 Example : An example can best illustrate the difference.
a. Suppose you bought a bond of face value Rs 100 and coupon rate is 10 %.
Every year, you'll get Rs 10 (here interest rate is also 10%).
b. Now, if you bought the bond above its face value(at premium), say at Rs 200,
you will still get a coupon rate of 10 % on the face value of Rs 100. It means
you'll still get Rs 10. But, since you bought bond at Rs 200, the rate of interest
this time would only 5 % (Rs 10 of Rs 200).
c. Likewise, if you bought the bond below its face value (discount), say at Rs 50,
you'll still receive Rs 10 every year, but this time interest rate would be 20 per
cent (Rs 10 of Rs 50).

How Are Coupon Rates Affected by Market Interest Rates?

 Inverse relationship.

 Market interest rate when they move lower or higher than a bond's coupon rate, the
value of the bond increases or decreases, respectively

What Is the Effective Yield?

 The effective yield is the return on a bond that has its coupon payments reinvested at
the same rate by the bondholder.
 It is the total yield an investor receives, in contrast to the nominal yield—which is
the coupon rate.
  Essentially, effective yield takes into account the power of compounding on
investment returns, while nominal yield does not.

Yield to Maturity (YTM)

 Total return anticipated on a bond if the bond is held until it matures.

 It is internal rate of return (IRR) of bond if investor holds bond until maturity, with all
payments made as scheduled and reinvested at the same rate.

 It is also referred as "book yield" or "redemption yield."

 Calculating YTM

a) It’s a complicated process, It is difficult to calculate precise YTM Value.

b) Calculations of yield to maturity (YTM) assume that all coupon payments are reinvested
at the same rate as the bond's current yield and take into account the bond's current
market price, par value, coupon interest rate, and term to maturity.
c) Instead, one can approximate YTM by using a bond yield table, financial calculator, or
online yield to maturity calculator

 As interest rates rise, the YTM will increase; as interest rates fall, the YTM will
decrease.

 Formula
o YTM = {(Annual Interest Payment) + [(Face Value – Current Trading Price) ÷
Remaining Years To Maturity]} ÷ [(Face Value + Current Price) ÷ 2]
o Online calculator link
https://www.omnicalculator.com/finance/yield-to-maturity

Uses of Yield to Maturity (YTM)

 Compare with required yield (return on a bond that will make the bond worthwhile)
to determine is it good buy

Limitations of Yield to Maturity (YTM)

 YTM calculations usually do not account for taxes that an investor pays on the bond.
 It makes assumptions about future that cannot be known in advance.
 Investor may not be able to reinvest all coupons, the bond may not be held to
maturity, and the bond issuer may default on the bond

Hence, YTM alone is not useful. We have to check ratings also.

 Always buy AAA or AA bonds.

 B grades bonds are B grade only.
  Instead of YTM, we can use PF ratio to compare bonds of same expiry, Ultimately
we buy bonds not YTM.

PF ratio = Price / Face value

 Price where we can buy bonds

o Discount (PF ratio < 1)
o Par value/ face value/ true value/ principal (PF ratio = 1)
o Premium (PF ratio > 1)
 Too much discount (PF less than 0.8) raises suspicion of poor quality.
 PF ratio is analogous to PE ratio of stocks.

What Is the Difference Between a Bond’s YTM and Its Coupon Rate?

 YTM of a bond will be higher if the price paid for the bond is lower and vice-versa.
 the coupon rate is fixed whereas the YTM fluctuates, based on the price paid for the
bond as well as the interest rates available elsewhere in the marketplace.
 At the time it is purchased, a bond's yield to maturity and its coupon rate are the
same
 Generally, a bond investor is more likely to base a decision on an instrument's
coupon rate. A bond trader is more likely to consider its yield to maturity
 To an individual bond investor, the coupon payment is the source of profit.
 To the bond trader, there is the potential gain or loss generated by variations in the
bond's market price.
 The yield to maturity calculation incorporates the potential gains or losses generated
by those market price changes

How to Buy Gsec Bonds?

1) PRIMARY MARKET: We can invest via Retail Direct Gilt (RDG) account. Using this
account, retail investors can buy and sell government securities through the online portal –
https://rbiretaildirect.org.in

Opening an RDG account will allow individuals to buy Government securities directly in the
primary market (auctions) as well as buy/sell in the secondary market.
 SECURITIES UNDER RDG ACCOUNT:
 Government of India Treasury Bills (T-Bills)
 Government of India dated securities (dated G-Sec)
 State Development Loans (SDLs)
 Sovereign Gold Bonds (SGB)

Who can open a Retail Direct Gilt (RDG) account?

a. Retail investors, that is, individuals (natural persons) are allowed to open an RDG account.
The following are required to open an account:

 Rupee savings bank account maintained in India.

 Permanent Account Number (PAN) issued by the Income Tax Department.
 Any Officially Valid Document (OVD) for Know Your Customer (KYC) purpose.
 Valid email id.
 Registered mobile number.

b. Non-Resident retail investors eligible to invest in Government Securities under Foreign

Exchange Management Act, 1999.

An individual can open only one RDG account. The second holder in a joint RDG account
may also open an individual RDG account.

The RBI Retail Direct Online Portal will facilitate the following:
Buying Government securities through primary auctions (non-competitive segment only).
 Buying and selling Government securities in the secondary market.
 Buying and selling Sovereign Gold Bonds (SGBs) in the primary and secondary market.
 Investor services such as account statement, nomination facility, pledge/lien, gift transactions,
grievance redressal, and managing profile like contact details etc.

The following documents are mandatory to open the RDG account

 PAN
 Mobile number
 E-mail address
 Scanned copy of your signature
 Bank account details (by uploading a cancelled cheque or manually entering the details on the
portal)
 Aadhaar number with mobile number linked to it

Nomination is compulsory for opening Retail Direct Gilt (RDG) Account.We can enter upto
two nominees.We can change nominee if needed.
There are two ways to buy Government securities through Retail Direct platform:

 By placing a bid in the primary auctions of dated G-Sec, T-Bills and SDLs (Non-competitive
segment only, i.e., by only entering the desired amount of securities, without entering a
price). For Sovereign Gold Bonds (SGBs), you may place a bid during the subscription
windows announced by RBI on its website. For step-by-step details on bidding in auctions,
you may refer to the User Manual on the Retail Direct Portal.
 By placing a buy quote in the secondary market portal.

What is the process for bidding in primary auctions through the Retail Direct platform?

 After logging into the Primary Market Retail Direct platform, select the ‘Primary Market’
option beside the Dashboard, at the top of the page.
 Select a security to bid from the ‘Auction Watch’ and enter the bid amount in the ‘Bid Entry’
window.
 Individuals can fund their bid either at the time of bidding or at a later time, but before the
closure of bidding/subscription window. Bids which are not funded as on the date of
submission of bids to RBI will be cancelled.
 For making payment for the bids, retail clients can use services like UPI (Transfer or Block)
and Net Banking to transfer funds to a designated current account using Payment Gateways
linked to the Online Portal.
 Based on the allotment advice received as a part of the auction result, the allotments will be
made to the individual investors.
 In case of full allotment, each bidder will be allocated the entire Face Value for which bids
were submitted. In case of partial allotment, a pro-rata allotment will be made to the bidder
based on the partial allocation percentage determined in the auction.
it's available only in web version not in mobile application. We will be allotted securities at
the weighted average price of the successful bids in the auction.

Markup (extra money blocked for application) is not a fee charged by RBI. It is refundable
depending upon the price at which the bids are allotted in the auction.In the non-competitive
segment of primary auctions, the price at which the securities are allotted is the weighted
average price of the successful competitive bids in the auction. Since this weighted average
price can be calculated only after the auction is over, the price of the security through the
non-competitive segment is unknown during the time of bidding. To cover for this
uncertainty, a markup is applied in case the weighted average price comes out to be higher.

The excess markup, i.e., the price charged at the time of placing the bid, minus the actual
allotment price, will be refunded to your linked bank account within two business days from
the date of auction.

The Scheme is designed to facilitate only Non-competitive participation (i.e., bids without
choosing your own price) by individuals.
Investors can earn fixed income at regular intervals through coupon payments. The rate of interest
payments would be specified as a percentage of the face value of the g-sec. Coupon payments are
paid to the investors periodically.

4. Pledging- Can pledge them and use the amount as Collateral for taking trades in F and O.

What are the disadvantages of Government Securities?

1. Low returns

Ideally, an asset would pay you for the risk that you take on when investing in them. This
additional return in compensation of the additional risk is called a risk premium. In the case of
government securities, this risk premium does not exist as they are assumed to be risk-free. Due to
this reason, the returns on government bonds tend to be lower than private bonds that have a
certain amount of risk associated with them.

2. Interest rate risk

Generally, when interest rates rise, the price of old government bonds will fall as new bonds with
higher coupon rates would become the preferred investment option. It is difficult to predict the
movements in interest rates, and thus, there is a price risk from interest rate changes. It should be
noted that the investors entering the transaction from issue, will not be affected by these changes if
they hold the bonds till maturity and collect the principal.

What are the different types of risks while investing in government bonds?
The following are the types of risks while investing in government bonds.

 Credit risk
 Inflation rate risk
 Interest rate risk
 Liquidity risk
 Reinvestment risk
 Market risk

Conclusion- Who should invest in Government Securities ?

 Government securities have maturities longer than fixed deposits, they are a good option
for investors looking to earn a stable fixed income. In addition, investors looking to
diversify their portfolio to lower the risk exposure of their portfolio may find G-secs
useful.
 Investors can buy G-secs after the issue date and sell them before maturity on the
secondary government securities market, allowing more flexibility, in case the investors
wish to liquidate investments.
 Compared to Liquidbees, Gsec provide better rate of return and may still pledge them like
liquidbees and make your money work for more money.