Government Securities Market: Characteristics, Features, Advantages, Risk, Types

  • Post last modified:09/01/2022
  • Reading time:27 mins read

What Is Securities Market?

Securities are negotiable financial instruments issued by a company or government that give ownership rights, debt rights, or rights to buy, sell, or trade an option. Securities are traded on the exchange markets. Although the term refers to all types of financial instruments, there are differences in its legal definitions, which most consider equities and fixed income as securities.

Securities can be stocks, bonds, mutual funds, interest-bearing treasury bills, notes, derivatives, warrants, and debentures. The legal entity that issues securities is the issuer of the security. Securities differ in their level of inherent risk.

For example, equities are considered riskier than bonds, but also some equities are riskier than other equities. Depending on the level of risk that an investor wants to accept, he selects the relevant securities.

Moreover, securities differ in their level of liquidity. Highly liquid securities like bonds, equities and money market instruments are traded more frequently because investors can increase their price by buying more securities and realizing a higher return on investment.


Characteristics of Security

These are the features or characteristics of security summarized below:

  1. Return
  2. Risk
  3. Safety

Return

The return may be received in the form of yield plus capital appreciation. The difference between the sale price and the purchase price is capital appreciation. The dividend or interest received from the investment is the yield. The return from an investment depends upon the nature of the investment, the maturity period and a host of other factors.

Return = Capital Gain + Yield (interest, dividend etc.)

Risk

Risk refers to the loss of the principal amount of investment. It is one of the major characteristics of an investment. The risk depends on the following factors:

  1. The investment maturity period is longer; in this case, investor will take larger risk.

  2. Government or Semi -Government bodies are issuing securities which have less risk.

  3. In the case of the debt instrument or fixed deposit, the risk of above investment is less due to their secured and fixed interest payable on themfor example debentures.

  4. In the case of ownership instrument like equity or preference shares, the risk is more due to their unsecured nature and variability of their return and ownership character.

  5. The risk of degree of variability of returns is more in the case of ownership capital compare to debt capital. The tax provisions would influence the return of risk.

Safety

Safety refers to the protection of investor principal amount and expected rate of return. Safety is also one of the essential and crucial elements of investment. Investor prefers safety about their capital. Capital is the certainty of return without loss of money or it will take time to retain it.

If an investor prefers fewer risk securities, he chooses Government bonds. In this case, investor who prefers a high rate of return investor will choose private Securities and the Safety of these securities is low.

Liquidity

Liquidity refers to an investment ready to convert into a cash position. In other words, it is available immediately in cash form. Liquidity means that investment is easily realizable, saleable or marketable. When the liquidity is high, then the return may be low. For example, UTI units.

An investor generally prefers liquidity for his investments, the safety of funds through a minimum risk and maximization of return from an investment.


Government Securities Market

The government generates revenue in the form of taxes and income from the ownership of assets. Besides these, it borrows extensively from banks, financial institutions, and the public to finance its expenditure in excess of its revenues. Government Securities are financial instruments and securities issued by a government towards raising a loan from the public.

The intention of raising government securities is to finance important projects and budget deficits. Government securities comprise of bearer bonds, promissory notes, bonds held in the bond ledger account, etc.

These can be in the form of dated government securities or treasury bills. Under normal circumstances, every country’s government finance is operations, infrastructure development, defence and public spending from revenues earned from direct and indirect taxation and levies imposed in income earned by individuals and businesses, the sale of goods and services, imports, etc.

However, many times, the income generated by the government might not be sufficient to support its public expenditure and infrastructure investment requirement; as a result of this, the Government can fill this gap by raising funds from the public and issuing them government securities in return. As a result of this, government securities are mainly issued to finance the portion of government expenditure and capital infrastructure requirements.

Most government securities issued by the Reserve Bank of India on behalf of the Indian Government are interest-bearing dated instruments. These government securities have a fixed maturity period, and these fixed coupon securities carry a half-yearly coupon interest.

As these Government Securities have a specified maturity date, these are also referred to as dated government securities. Most government securities are issued in dematerialized form but can be issued in physical form upon request. Physical Government Securities are issued in multiples or denominations of Rs. 10000/- and the tenor of these government securities can be extended for a period of 30 years.


Features of Government Securities

Some of the most common features of Government Securities are as follows:

  1. Government Securities are issued at face value.

  2. Government Securities carry a sovereign guarantee and hence have zero risks of default.

  3. Investors can sell these Government Securities in the secondary market.

  4. Payments of Interest on Government Securities are paid on its face value.

  5. The interest payment on these Government Securities does not attract TDS, or Tax Deducted at Source.

  6. Government securities can be held in dematerialized form.

  7. The interest rate of Government Securities is fixed for the entire tenor of the instrument and cannot be changed during its tenor.

  8. The Government Securities are redeemable at face value at the time of its maturity.

  9. The maturity period of Government Securities can range between 2 to 30 years.

  10. Most Government Securities qualify as SLR or Statutory Liquidity Ratio investments

Advantages of Government Securities

The Reserve Bank of India issues government securities on behalf of the Indian Government in the form of interest-bearing dated securities. The securities have a fixed rate of interest, a fixed maturity period and carry half-yearly interest payments. The market value of government securities, similar to stocks is also subject to market risk.

The prices of these instruments are often linked to the prevailing rate of interest. The price of government securities falls when the interest rates rise, and the price of government securities rise when the interest rates fall.

As a result of this, buying government securities when the rate of interest is high at low rates and selling them at a higher price when the rate of interest fall can help investors make substantial gains. Some of the advantages of investing in Government securities include:

  1. Government securities offer lower volatility and greater safety when compared to corporate bonds.

  2. Government securities do not attract TDS deduction on interest payment.

  3. Government securities offer transparent transactions and simplified settlement procedures through NSDL/CSGL.

  4. Government investments offer higher diversification opportunities for investors.

  5. Investors are offered higher leverage while borrowing against government securities.

  6. 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.

  7. 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.

  8. 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.

  9. G-Secs can also be used as collateral to borrow funds in the repo market.

  10. Securities such as State Development Loans (SDLs) and Special Securities (Oil bonds, UDAY bonds etc.) provide attractive yields.

  11. 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.

  12. G-Sec prices are readily available due to a liquid and active secondary market and a transparent price dissemination mechanism.

Risk in Government Securities

The following are the major risks associated with holding G-Secs:

  1. Market Risk
  2. Reinvestment Risk
  3. Liquidity Risk

Market Risk

Market risk arises out of the 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.

Reinvestment Risk

Cash flows on a G-Sec include 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 the investment due to a decrease in interest rates prevailing at the time of receipt of cash flows by investors.

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 the non-availability of buyers for the security, i.e., no trading activity in that particular security or circumstances resulting in the distressed sale (selling at a much lower price than its holding cost) causing loss to the seller.

Usually, when a liquid bond of fixed maturity is bought, its tenor gets reduced due to time decay.


Segments of Dated Government Securities in India

These are the segments of dated government securities in India:

  1. Primary Market
  2. Secondary Market
  3. Auction

Primary Market

The Primary Market for government securities includes the issuer of these securities. It includes the State and Central Government, buyers such as primary dealers, commercial banks, financial institutions, and insurance companies. The Reserve Bank of India also allows small investors to invest in government securities through its non-competitive bidding.

Secondary Market

The Secondary Market for government securities includes the Reserve Bank of India and various commercial banks, mutual funds, insurance companies, trusts, provident funds, primary dealers, etc. Individuals and corporates can also invest in government securities.

Auction

Government securities are also sold through the process of auction, though they can also be sold on the OMO or Open Market Operations. The process of auction involves calling of bids to arrive at a market price. The auction of government securities is generally priced on the basis of price or yield.

  1. In Price-based Auctions: The Reserve Bank of India makes an announcement regarding the size of the issue, the notified amount, tenor of the instrument, coupon rate of the paper, etc. The bidders are required to submit their bids, i.e., their price. Bids which are lower than the cut-off price are rejected, and bids higher than the cut-off price are accepted. A price based auction is intended to derive a price discovery for the instrument.

  2. In Yield-based Auctions: The Reserve Bank of India makes an announcement regarding the notified amount or issue size of the government security, and the tenor of the instrument to be auctioned. The bidders are required to submit bids in term of the yield. Bids which are lower than the cut-off yield are rejected, and bids higher than the cut-off yield are accepted.

Types of Government Securities in India

The Reserve Bank of India issues the following types of Government Securities on behalf of the Government of India:

  1. Treasury Bills
  2. Cash Management Bills
  3. Dated Government Securities
  4. Fixed-Rate Bonds
  5. Floating Rate Bonds (FRB)
  6. Capital Indexed Bonds
  7. Inflation-Indexed Bonds (IIBs)
  8. Bonds with Call/Put Options
  9. Special Securities
  10. STRIPS
  11. Sovereign Gold Bond (SGB)
  12. 7.75% Savings (Taxable) Bonds, 2018
  13. State Development Loans

Treasury 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 days, 182 days and 364 days.

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/-.

Cash Management Bills

Cash management bills are government securities issued with a short validity, which is usually less than 91-days. These are highly flexible financial instruments, and their tenure is dependent on the cash needs and requirements of the Government.

Cash management bills are similar to treasury bills and do not pay the instrument holder any form of interest. Instead, the difference between the face value of the instrument and its discounted issue price serves as the profit or gains for the investor.

In 2010, the Government of India, in consultation with RBI introduced 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.

Dated Government Securities

Dated Government securities are securities and bonds issued by the Reserve Bank of India on behalf of the Government, and these bonds have a predetermined or fixed maturity date. The Reserve Bank of India sells these bonds or government securities on auction.

Dated Government securities can be issued as bonds with call or put options, capital index bonds, zero-coupon bonds, fixed and floating rate bonds, etc. Dated government security instruments are as follows.

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 – 8.24%GS2018 was issued on April 22, 2008, for a tenor of 10 years maturing on April 22, 2018. Coupons on this security will be paid half-yearly at 4.12% (half-yearly payment being half of the annual coupon of 8.24%) of the face value on October 22 and April 22 of each year.

Floating Rate Bonds (FRB)

FRBs are securities that 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). FRBs were first issued in September 1995 in India. For example, an FRB was issued on November 07, 2016, for a tenor of 8 years, thus maturing on November 07, 2024.

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.

Inflation-Indexed Bonds (IIBs)

IIBs are bonded wherein both coupons flows and Principal amounts are protected against inflation. The inflation index used in IIBs may be the Whole Sale Price Index (WPI) or Consumer Price Index (CPI). Globally, IIBs were first issued in 1981 in the UK. In India, the Government of India through RBI issued IIBs (linked to WPI) in June 2013.

Bonds with Call/Put Options

Bonds can also be issued with features of optionality wherein the issuer can have the option to buy back (call option) or the investor can have the option to sell the bond (put option) to the issuer during the currency of the bond. It may be noted that such bond may have put only or call only or both options.

The first G-Sec with both call and put option viz. 6.72% GS 2012 was issued on July 18, 2002, for a maturity of 10 years maturing on July 18, 2012. The optionality on the bond could be exercised after the completion of five years tenure from the date of issuance on any coupon date falling thereafter.

The Government has the right to buy back the bond (call option) at par value (equal to the face value) while the investor had the right to sell the bond (put option) to the Government at par value on any of the half-yearly coupon dates starting from July 18, 2007.

Special Securities

Under the market borrowing program, the Government of India also issues, from time to time, special securities to entities like Oil Marketing Companies, Fertilizer Companies, the Food Corporation of India, etc. (popularly called oil bonds, fertiliser bonds and food bonds respectively) as compensation to these companies in lieu of cash subsidies These securities are usually long-dated securities and carry a marginally higher coupon over the yield of the dated securities of comparable maturity.

These securities are, however, not eligible as SLR securities but are eligible as collateral for market repo transactions. The beneficiary entities may divest these securities in the secondary market to banks, insurance companies / Primary Dealers, etc., for raising funds.

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). However, they are created out of existing securities only and unlike other securities, are not issued through auctions. Stripped securities represent future cash flows (periodic interest and principal repayment) of an underlying coupon-bearing bond.

Being G- Secs, STRIPS are eligible for SLR. All fixed coupon securities issued by the Government of India, irrespective of the year of maturity, are eligible for Stripping/Reconstitution, provided that the securities are reckoned as eligible investments for the purpose of Statutory Liquidity Ratio (SLR) and the securities are transferable.

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.

7.75% Savings (Taxable) Bonds, 2018

The government of India has decided to issue 7.75% Savings (Taxable) Bonds, 2018 with effect from January 10, 2018, in terms of GOI notification F.No.4(28) – W&M/2017 dated January 03, 2018, and RBI issued notification vide IDMD.CDD.No.1671/13.01.299/2017-18 dated January 3, 2018.

State Development Loans

The State Government issues state development loans with the purpose of meeting their budget deficit and budgetary requirements. These bonds are issued in facilitation with the Reserve Bank of India using the negotiated dealing system. The rate of interest offered by state development loans is higher than dated government bonds.


FAQ Related to Government Securities Market

What Is Securities Market?

Security Market: It’s where trades of securities such as stocks and bonds take place based on demand and supply

What are government securities market?

Government Security: Government securities are debt instruments that a sovereign government.

What is Debentures?

Debentures: A long-term security yielding a fixed rate of interest, issued by a company and secured against assets.

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