Government Securities

--- tags: bonds --- # Government Securities A government security is a type of bond issued by the Central Government or the State Governments. They are broadly classified into two main categories based on the duration. * **Short Term Bonds** - Colloquially known as Treasury Bills (T Bills), these are secrurities that are issued for durations shorter than a year. Generally, only the central government issues this type of securities. * **Long Term Bonds** - These are dated securities which are sometimes referred to as GSecs (despite only being a subset of government securities). There are issued by both the central government as well as the state governments. When issued by the latter they are reffered to as State Development Loans (SDLs). Due to being issued by the government itself, these bonds are a form of sovereign debt and have low credit risk. The overall risk of a nation's bond can be assessed by looking at their sovereign credit rating which is an assesment of the creditworthiness of a country. For example, India's credit rating as of this article is BBB- according to Fitch and Baa3 according to Moody's which is the minimum grade required for a bond to be considered "investment grade". ## Short Term Bonds ### Treasury Bills As mentioned in the previous section, these are short term money market instruments issued by the central government. They are available in three durations - 91 day, 182 day and 364 day T Bills. These are zero coupon instruments that do not pay out any interest and instead the interest component is the difference between the price the face value and the price they are are sold at. --- Thumb rule calculations would work like this: * 91 days bill = 3 months = 1/4 year * 182 days bill = 6 months = 1/2 year * 364 days bill = 12 months = 1 year For example, the 91 day bill can have a face value of ₹100 and issued at ₹98. That means you can purchase it at ₹98 and when it completes 91 days, you will sell it back and get ₹100. Cost of ₹98 and payout of ₹100 with a profit of ₹2. This ₹2 is the interest over 3 months and the effective rate is about 8%. Detailed maths located below [^1] ### Cash Management Bills (CMBs) These are very similar in nature to treasury bills, however these are issued with maturities shorter than 91 days. Introduced in 2010, they help the government manage their cashflows. For example, RBI [recently announced the auction of a 48 day Cash Management Bill](https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=49282) ## Dated G-Secs These are bonds issed by the government with fixed or floating coupon rates payable half yearly on the face value. There are a large number of bonds that fall under this category of bonds. ### Fixed Coupon G-Secs These are bonds where the interest rate is fixed for the entire duration of the bond and is set at the time of issue. Due to this they may have fluctuations in price on the secondary markets when there is a rise or fall of prevailing interest rates. ### Floating Rate Bonds (FRB) These are bonds where the interest rate is not fixed for the entire duration of the bond and is revised at fixed intervals by RBI. There come in two main types. * Floating rate bonds without a fixed spread ie they are simply issued at face value and pay out the coupon rate for the currently set period. * Floating rate bonds with a fixed spread. These are auctioned and sold at a discount similar to the aforementioned treasury bills, which means there's a variable component which is the coupon yield set by RBI as well as the fixed spread which is guaranteed based on the discount the bond was purchased at. An example of this type of bond is the [FRB 2033 issued by RBI.](https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=50728) #### Floating Rate Savings Bond Retail investors also have the option to invest in Floating Rate Savings Bonds offered by RBI which are a simple way to hold government bonds for individual retail investors instead of FIIs/DIIs or HNIs. These are floating rate bonds offered by RBI. These are successors to the 7.75% Savings (Taxable) Bonds, 2018 which were fixed rate bonds issued by RBI with both cumulative as well as non cumulative options. The FRSB is however, only available in the non cumalative option and investment starts at ₹1,000 and in multiples of ₹1,000, thereof without a maximum investment limit. The interest is fully taxable at slab limits and the interest rates are set to revision by RBI every six months. The main thing to note is that unlike most other bonds *these can not be traded on the secondary markets, nor can they be used as collateral for loans*. ### Inflation Indexed Bonds (IIBs) For some duration post the Global Financial Crisis, inflation was a major concern for most emerging markets. To alleviate this, RBI launched Inflation Indexed Bonds, these are bonds where both the principle as well as the interested rates are matched to the Whole Sale Price Index (WPI) or Consumer Price Index (CPI). On their release however, RBI had used WPI though currently the RBI has switched to using the CPI as their measure of inflation. Future issues are likely to be matched with CPI over WPI. In recent years, much of the sheen of these are fallen with inflation levels falling much lower. The government has announced a couple of buy backs of these bonds providing investors an exit. Those familiar with the US bond markets will find this very similar to Treasury Inflation-Protected Securities or TIPS. ### State Development Loans (SDLs) State Development Loans are securities issued by various state governments instead of the the central government. In theory based on the Basel III guidelines as well as RBI's Statutory liquidity ratio requirements, these are considered to be having zero credit risk. In the markets this is contested as there is often a premium over the central government's equivalent government security. The spread depends on the credit worthiness of the states in question and can vary from state to state. Since RBI is the facilitator for the state to issue such bonds they have the power to make payments to bond holders from the central government's kitty for the respective state. ### Sovereign Gold Bonds (SGBs) These are very special types of bonds that do not function in a similar manner to the other bonds listed on this page. Instead they are pegged directly to the price of gold acting as a proxy to actually holding gold. Furthermore they offer 2.5% simple interest and capital gains for bonds held to maturity are currently zero. [For more on this read up our detailed page on holding SGBs.](https://UNDER-CONSTRUCTION) ## Extended Reading If you want to read more about bonds and their pricing, I strongly recommend reading the [RBI FAQs on bonds](https://m.rbi.org.in/Scripts/FAQView.aspx?Id=79). [^1]: For example, a 91 day bond with the face value of ₹100 when first issued can be sold at ₹97.2. This means the interest for holding this bond to maturity is `₹100 - ₹97.2 = ₹2.8`. Nominally, this yield would be `(2.8/ 97.2) * 100` which is 2.88% yield. We can annualize this to be around 11.55% per annum. To formalize this into a formula that a bond trader may use: `Annualized Yield = Interest for the duration of the bond * Modifier` The first part of the formula can be understood as `(Face Value - Issue Price) * 100 / Issue Price`. Which in our example ended up being 2.88%. The second part of the formula is a modifier that would convert the yield from an absolute return to an annualized one. Mathematically this would be `(365 / Duration of bond in days.)`. Comprehensively, the annualized yield works out to be `Annualized Yield = [(100-P)/P]*[365/D]*100` where `P` is the price of issue and `D` is the duration in days.