Bonds are debt securities that allow an investor to lend money to a company. The entity borrows money for a set period at a predetermined interest rate. Governments, banks, and corporations are examples of such entities. As a result, government bonds are referred to as such when the government issues them. These investments are also referred to as fixed-income investments. In this post, we’ve gone through government bonds in-depth, including their types, benefits, and drawbacks.
How do you define government bonds ?
A government bond is a debt instrument issued by the country’s central and state governments to fund their needs while also regulating the money supply. Bonds are frequently used by governments to raise revenue for infrastructure development and to finance government spending. As a result, the government will issue bonds to the general public, attracting investment. At the bond’s maturity date, the government will repay the principal and interest according to the bond’s terms. The Reserve Bank of India supervises the issuance of government bonds (RBI).
To finance the budget imbalance, the RBI issues bonds on behalf of the Indian government. The bonds have been issued to significant market participants such as businesses, commercial banks, and financial institutions in recent years. Government bonds have been more accessible to smaller investors in recent years, such as individual investors, cooperative banks, and so on. Individual investors are also showing a strong interest in government bonds.
Government bonds are, in general, long-term investment vehicles in India. These bonds are for an extended period, ranging from 5 to 40 years. Furthermore, government bonds are included in the category of government securities (G-secs). Government bonds can be issued by both the federal and state governments. State Development Loans, on the other hand, are bonds issued by state governments (SDLs).
The Government of India (GOI) offers many bond types. Furthermore, these bonds are designed to meet the needs of a wide range of investors. The coupon rate is the interest rate offered on a government bond. The coupon might be fixed or floating, and it is paid out twice a year. Generally, the Government of India issues bonds with fixed coupon rates on the market.
Types of Government Bonds
1. Treasury Bills
T-bills are short-term government bonds, often known as Treasury bills. They are issued with a one-year maturity date. The government offers three different types of bonds: 91 days, 182 days, and 364 days. There are no coupon payments made to the investors. The difference between the face value and the discounted value, on the other hand, is the profit made by the investors.
2. Bills for Cash Management
These bonds are short-term investments with a lot of flexibility. They are issued in response to the government’s funding requirements. As a result, the bond’s maturity is mostly determined by short-term liquidity requirements. They must usually be shorter than 91 days. Treasury bills are pretty similar to this.
3. Dated Government Securities
This sort of bond has a range of interest rates. The interest paid on these bonds will benefit the investors. Due to the factor of a specified maturity date, government securities are referred to be “dated.” These bonds are auctioned by the Reserve Bank of India. The types of dated government securities are as follows.
4. Fixed-Rate Bonds
This type of government bond has a set coupon rate for the duration of the bond. In other words, regardless of market rates, the interest rate remains constant throughout the investment period.
5. Bonds with a Floating Rate
The interest rate on these bonds fluctuates over the investment period, as the name implies. Interest rate modifications are made at pre-determined intervals before the bond is issued. A floating-rate bond (FRB), for example, has a 6-month pre-announced interval. It indicates the interest rate will reset every six months for the duration of the loan.
6. Zero-Coupon Bonds
Zero-coupon bonds have no coupon payments, as the name implies. The gap between the issue price and the redemption value is where the earnings from these bonds come from. To put it another way, these bonds are sold at a discount and then repaid at face value. Furthermore, these bonds are formed from existing securities rather than being offered through an auction.
7. Bonds with a capital index
The capital index bonds have a principal amount that is tied to an accepted inflation index. This bond is issued to protect investors’ principal against inflation.
8. Inflation-Indexed Bonds
The principal amount and interest payment on Inflation Index Bonds (IIBs) are linked to an inflation index. The Consumer Price Index (CPI) or the Wholesale Price Index (WPI) are two examples of inflation indexes (WPI). Investing in such bonds ensures a steady stream of actual returns. It can also protect an investor’s portfolio from rising inflation rates.
9. Bonds with a Call or Put Option
These bonds include a call option, which allows the issuer to buy back the bond, or a sell option, which allows the investor to sell bonds to the issuer (put option). Only five years after the date of issue can the investor or issuer exercise their rights.
10. Special Securities
The Indian government offers special securities to firms including oil marketing companies, fertilizer companies, and the Food Corporation of India from time to time. Instead of monetary subsidies, the government issues these securities as compensation to these businesses.
Separate Trading of Registered Interest and Principal of Securities is referred to as STRIPS. Each cash flow from a fixed-rate bond gets transformed into separate security here. They’re then sold on the secondary market. They also have a lot in common with zero-coupon bonds. They are, nevertheless, generated from existing securities.
12. Sovereign Gold Bonds (SGBs)
The price of sovereign gold bonds is linked to the price of gold (commodity price). The bond’s nominal value is determined using the previous week’s simple average closing price of 99.99 percent pure gold. The price list is published by the India Bullion and Jewellers Association Ltd (IBJA). These bonds have a one-gram gold denomination. SGBs are issued by the central government, allowing investors to buy gold without having to invest in physical gold. Furthermore, the interest on these bonds is exempt from individual taxation. Additionally, investors seeking liquidity from these bonds will have to wait five years to redeem them.
13. 7.75% GOI Savings Bond
The GOI savings bond, which replaced the 8% savings bond, was introduced in 2018. The interest rate on this bond is 7.75 percent, as stated in the nomenclature. The interest earned on these bonds is taxable according to the investor’s income tax slab rates under the Income Tax Act of 1961. The minimum investment amount is INR 1000 and multiples thereof.
14. Loans to States for Development (SDLs)
To address its budgetary needs, the state government issues bonds. As a result, they’re referred to as State Development Loans (SDLs). The issuing of these bonds is facilitated by the RBI through a negotiated dealing procedure. Security is usually issued every two weeks by the government. SDLs also pay a greater interest rate than Dated Government Bonds. The bond’s interest rate, on the other hand, can only be determined during the auction.
Should one invest in govt bonds ?
Retail investors were only allowed to participate in government bond auctions after 2001, with a non-competitive bidding cap of 5% of the total amount sought by the government. Institutional investors, such as banks, primary dealers, financial institutions, mutual funds, and insurance companies, make up the majority of bidders at the auction.
Individuals, companies, corporate bodies, and any other institutions with a current account or a subsidiary general ledger are considered retail investors by the Reserve Bank of India (SGL). Should an individual, on the other hand, invest in them? Why not, right? They’re a good way to diversify your portfolio and reduce your risk of being exposed to a single asset.
Government bonds provide a well-diversified portfolio for investors because they reduce overall portfolio risk. Furthermore, investing in certain bonds can help you save money on taxes. For example, tax-free bonds issued by the National Highway Authority of India (NHAI) or the Rural Electrification Corporation Limited (RECL) are not only safe investments, but they are also exempt from wealth tax and do not have any TDS deducted from the interest.
Investing in sovereign gold bonds is another way for investors to avoid paying capital gains tax. These are government securities as well, but they are denominated in gold grams. They are not only a cost-effective alternative to owning physical gold in terms of capital gains tax and making fees, but they also provide the investor with the current market price of gold at the time of redemption/premature redemption. However, one should only invest in bonds if one is unable to take risks. It aids in the maintenance of a regular income in such a situation. Those approaching retirement age, in particular, should choose safe investment options such as government bonds. Meanwhile, due to their higher risk tolerance, youthful investors in their 30s can invest 30% in bonds and the remainder inequities.
Who should consider purchasing government bonds?
In India, government bonds are one of the safest investments. It is appropriate for people who desire security in their investments and have a low-risk tolerance. Investing in market-linked assets usually comes with the risk of capital appreciation. As a result, they can be used as a long-term investment choice for investors who are new to the stock market. Furthermore, investors might buy government bonds to diversify their investment portfolio’s overall market risk.
The Indian government has recently taken several steps to ensure that government securities are better understood and popular among ordinary investors. Furthermore, they have streamlined the subscription process for regular investors.
For example, the Government of India has implemented a Non-Competitive Bidding mechanism for some government bonds. Market players can easily put their minimum bids online using this service. Select websites and mobile applications can be used to place the minimum bid.
Finally, investors who want to diversify or dilute their portfolio might consider government bonds (fixed income instruments). Those intending to start a business can also invest their spare funds in government bonds.
Advantages and Disadvantages of Government Bonds
When considering investment possibilities, most people think of shares, fixed deposits, mutual funds, real estate, or gold. Investing in government bonds is a rare occurrence. Government bonds, on the other hand, can be a good strategy to diversify your portfolio and reduce risk. When government spending exceeds revenue, the government issues securities, commonly referred to as G-secs or government bonds, to raise funds to pay the deficit. Treasury bills and dated securities are two types of government bonds. Treasury bills are short-term instruments with a one-year maturity, whereas long-term government bonds have a maturity of 5 to 40 years.
The Reserve Bank of India is in charge of government bond issuance in India. Previously, the central bank would auction government bonds in big tranches, which banks, mutual funds, and insurance firms would purchase. With the launch of the non-competitive bidding process in 2017, the RBI opened up the bond markets to ordinary investors. Small investors can now use mobile apps like NSE goBID and BSE Direct to purchase government bonds worth a minimum of Rs 10,000.
1. Advantages of Government Bond Investing
Even though government bonds are now available to retail investors, deploying funds without first weighing the benefits and drawbacks can be unproductive. Government bonds are less risky than other assets like shares since the government guarantees the returns.
There are some market dangers, but you can eliminate them by just holding the bonds until they mature. The government pays a fixed interest rate on the bonds, and you can get the best return by investing in government bonds until they mature. To diversify one’s portfolio, one can invest in government bonds, which are relatively stable and perform well when other asset classes are under pressure.
2. Disadvantages of Government Bond Investing
Government bonds have various advantages, but they also have some disadvantages. Government bonds, in principle, provide ample liquidity due to high demand from huge financial institutions. Financial entities, on the other hand, buy in big quantities, and a retail investor cannot sell his or her bonds to banks or insurance firms. The secondary market for government bonds has not yet completely formed, reducing government bond liquidity. Liquidity, on the other hand, will not be an issue if you invest over a long period.
While government bonds can be purchased directly, they need extensive research and active engagement, similar to stock investing. Bond exchange-traded funds are a simpler and more economical way to invest in government bonds. Bond ETFs can be a good way to invest in bonds issued by the government, businesses, and government-owned enterprises. Bond ETFs, unlike government bonds, may be easily exchanged on exchanges, providing investors with much-needed liquidity.
Bond ETFs are designed to match debt indices, increasing diversification while lowering risk. Bond ETFs can also be used to invest in lesser quantities. Government bonds need a minimum investment of Rs 10,000, although bond ETFs can be purchased for as little as Rs 1,000. Bond ETFs are the best way to invest in government bonds if you have a long-term investing goal and want a transparent investment option with low risk.