Understanding Government Securities and State Development Loans
Introduction: The New Beginning
The National Stock Exchange (NSE) in collaboration with the Reserve Bank of India (RBI) has allowed retail investors to invest in Government Securities (G-Secs) since April 2018. Formerly, these G-Secs were used by financial institutions like banks. But now, the individual investors can also invest in secured long term government securities.
Government Securities such as long-term bonds and Treasury Bills (T-bills) are a promising portfolio investment to retail investors. These instruments provide fixed and assured incomes, thus, investment in these instruments has no risk associated with it since it is endorsed with the Government of India. However, there is always a need to understand these instruments before investing in them. This article is written with the intent to help you invest better by explaining the concept of G-Secs in a simple, yet comprehensive, manner.
What Is Meant by Government Securities (G-Secs)?
The G-Secs can be understood as a process whereby one lends money to the Government of India. This process enables the government to borrow money which is then used to fund infrastructure development like construction of roads, bridges and hospitals. The government through the RBI uses these G Secs to borrow money or raise funds in the financial market.
In return, the government agrees to pay regular interest on the principal amount as well as to redeem the security at face value upon the termination of its maturity period.
Government securities are broadly classified into two categories:
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Treasury Bills (T-bills): They are highly liquid with maturity periods less than one year, and they help in conserving cash to meet the project’s other needs. People buy them at lower price than its face value and they can be cashed at face value after maturity.
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Government Bonds: These are the long-term securities with their maturity period ranging from 5 to 40-year period. It pays its interest half-yearly and after the time of maturity, it gives back the principal.
Treasury Bills (T-bills): There are Short Term, High Security Investment.
Understanding T-bills:
T-bills are short term government securities with a market with various tenors of 91 days, 182 days and 364 days. T-bills on the other hand, do not attract any interest as they are short term instruments. They are unlisted and are sold at a cheaper price compared to their face value and at maturity you only get a face value.
For instance, if a 91-Day T-bill has its face value at Rs. 100, and it is available at Rs.97, when the bill matures, you’ll be paid Rs.100. Here Rs.3 = Your earnings.
Calculating Yield on T-bills:
In order to compare T-bills, return with other investments you make, it’s necessary to make an average or annualized yield.
The yield can be calculated using the formula:
For example, if you earn Rs. 3 on a 91-day T-bill purchased for Rs. 97, the annualized yield would be:
Yield=(397)×(36591)=12. 41%
This yield is your investment’s total return expressed on an annual basis so that it can easily be compared with other investment opportunities.
Maturity and Redemption:
When a T-bill matures, the government sell T-bill from the Demat account, and the face value is credited to the linked bank account. This process is known as the “Extinguishment of Securities” to facilitate the transaction of securities in a sound and efficient manner.
Government Bonds: Long-Term, Interest-Bearing Investments
Understanding Government Bonds:
Government bonds are fixed income securities which carry interest which is paid on a half-yearly basis . The interest rate often referred to also as the coupon rate is fixed in advance and does not change over the life cycle of the bond.
Each bond has a unique identifier, such as "740GS2035A" which contains essential information:
• 7. 40%: The annual rate of interest also known as the annual percentage rate of interest charged.
• GS: Indicates that it is a Government Security.
• 2035: The year of maturity.
• A: represents a fresh issue
For example, if you choose to invest in a bond and the interest rates expected from the bond is 7.40% annualized interest rate which is due in 2035, you will get 3.7 % compounded interest rate which is calculated every six months and to be paid on bond maturity date .
Investment Example:
For instance, consider that you have bought a bond with a coupon rate of 7%, having a maturity date of 2030 and you bought the bond at the discount price of Rs. 98. 4. If you buy 150 bonds you will be able to invest Rs. 14,760. Through its life cycle, you would receive a half-yearly coupon payment and at the end of the bond’s duration, the face amount is paid back. The total earnings would be:
The expenditure on all of them will be
Rs. 525+525+525+525+15,000 = Rs 17,100
This is a good example to show how bonds’ investments can offer steady and sustainable income.
Yield to Maturity (YTM):
YTM is relatively more complex and has the feature of assuming the interest earned are reinvested to purchase more of the same bond and yields compound interest. YTM is normally used by institutional investors as a relative index when comparing different bonds. Although it reflects a closer picture of the total returns, over the period it takes expertise in the bond market.
Interest Payments:
Coupon or interest payable on government bonds reaches your bank account which is usually linked with your Demat account. It is the same as the process of receiving dividends in the stocks which provides constant and steady revenue generation.
The Auction Process: How Prices Are Determined
Understanding the Auction Process:
Formerly, G-Secs were available only for banks and other large financial organizations along with a minimum investment value of Rs.5 crore. But the recent reforms have been extended to retail investors where they can place their money for a minimum of Rs.10,000.
There are ways of arriving at your bid in government securities through an auction system. There are bids from major financial institutions provided to RBI’s auction facility and the auction process decides the price per bond. This goes a long way in the establishment of the “weighted average price” of the bond.
Amount Payable vs. Weighted Average Price:
When you bid, you pay a slightly higher price referred to as the ‘amount payable ‘ Upon the closing of the auction the RBI computes the weighted average prices and any differences between the amount payable and the WAP is credited back to the customer.
Secondary Market Trading:
Government bonds may be bought and sold in the secondary market like stocks also. If you are interested in selling the bonds before their time of maturity, you exercise this through NSE. This helps in the management of investment depending on the predetermined set objectives regarding the investment.
State Development Loans (SDLs): Investing in State Government Securities
Understanding SDLs:
State Development Loans or SDLs are securities which are floated in the market by the state governments in order to finance their budgetary needs. Like bonds issued by the central government, these loans provide semi-annual coupons and principal repayments at the end of the maturity.
Like most other structures, SDLs are endowed with an ‘Explicit Sovereign Guarantee’ and hence, qualified as zero risk weighted assets under the prudential norms set by RBI. This ensures the safety of your investment and this makes SDLs preferred by those investors who are willing to take less risk in the market.
Flotation and Yield:
These include the auctions of SDLs that are carried out through the RBI, with these auctions normally conducted on a fortnightly basis. These securities are traded through electronic medium on the RBI operated NDS OM (Negotiated Dealing System–Order Matching).
For example, consider the security "05. 75APSDL2024. " Here's what it means:
• 5. 75%: Usually expressed as the annual rate of interest which means the interest in the course of a year.
• AP: This figure comprises various components such as Andhra Pradesh (State Code).
• SDL: Stating that it is a State Development Loan.
• 2024: The year of maturity In this stage, the growth of all the financial features will be stable and mature, and the financial goals will also be fully achieved.
In this security, you will get 2, if you invest in it. Nine hundred seventy-five percent per six months until 2024, and of the principal at the end of the loan.
Risk Assessment:
While G-Secs bear mostly the tag of ‘Implicit Sovereign Guarantee,’ SDLs have what is referred to as ‘Explicit Sovereign Guarantee,’ therefore while rating them, the RBI norms assign SDLs to zero risk weight – thus making SDLs drastically safer bet for your money.
Conclusion: The Future of Retail Investment in G-Secs and SDLs
The opening up of G-Secs and SDLs to retail investors marks a new era in the Indian financial market. These instruments offer a unique combination of safety, attractive returns, and long-term stability, making them an ideal choice for risk-averse investors.
With the RBI and NSE facilitating easy access to these securities, retail investors can now diversify their portfolios and take advantage of the benefits traditionally reserved for large institutions. Whether you are looking for short-term gains through T-bills or long-term income through bonds and SDLs, these government securities provide a secure and rewarding investment opportunity.
As you explore the world of G-Secs and SDLs, remember to stay informed about auction schedules, yield calculations, and secondary market opportunities. With a solid understanding of these instruments, you can confidently navigate the complexities of government securities and achieve your financial goals.
Frequently Asked Questions
What are Government Securities (G-Secs)?
Government Securities (G-Secs) are debt instruments issued by the government to borrow money for infrastructure projects. They offer regular interest payments and return the principal amount at maturity.
How do Treasury Bills (T-bills) work?
T-bills are short-term securities with tenors of 91, 182, or 364 days. They are sold at a discount and redeemed at face value, making the difference your earnings.
What is the Yield to Maturity (YTM) for bonds?
YTM is the total return anticipated on a bond if it is held until maturity. It assumes interest earned is reinvested and is a key measure for comparing bonds.
What are State Development Loans (SDLs)?
SDLs are securities issued by state governments to fund budgetary needs. They offer semi-annual interest payments and are considered low-risk due to the explicit sovereign guarantee.
How does the auction process for G-Secs work?
G-Secs are sold via an auction where financial institutions place bids. The RBI determines the weighted average price, and any difference between your bid and this price is adjusted in your payment.
Disclaimer: This blog is dedicated exclusively for educational purposes. Please note that the securities and investments mentioned here are provided for informative purposes only and should not be construed as recommendations. Kindly ensure thorough research prior to making any investment decisions. Participation in the securities market carries inherent risks, and it's important to carefully review all associated documents before committing to investments. Please be aware that the attainment of investment objectives is not guaranteed. It's important to note that the past performance of securities and instruments does not reliably predict future performance.
