What Are Government Bonds?

Introduction

One of the interesting investing options today is the investment in government bonds or government securities through the retail direct route. Government bonds India are not as popular as in other countries since this market is still dominated by institutions like banks, insurance companies, mutual funds etc. Govt Bonds are one of the bluest of blue chip investments with zero default risk, although interest rate risk is quite high in these bonds.

Here we look at how can an Indian investor invest in government bonds or government securities. It has long been an institutional market but is now being preferred by individual also, due to its safety and flexibility. We also look at some of the best government bonds to buy based on yields.

Explain in details Government Bonds

Like any other debt instrument, government bond or government security is also a bond or a debt instrument. A bond is a debt instrument in which an investor loans money to an entity (typically corporate or government). Now the issuer (the government in this case) borrows the funds for a defined period of time; either at a variable or fixed interest rate. Why do governments and companies issue bonds? Bonds are used by NBFCs, companies, municipalities, banks, state governments and sovereign governments to raise money to finance a variety of projects and activities. Owners of bonds are debt holders, or creditors, of the issuer while the issuers of the bonds are the debtors.

Let us now focus on what is a government bond or government security as it is popularly called. A Government Bond or Government Security (G-Sec) is a tradeable instrument issued by the Central Government or the State Governments. What the government bond does is to acknowledge the Government’s debt obligation to the investor. These can be short term (treasury bills or T-bills with original maturity less than 1 year) or long term (Government bonds or dated securities beyond 1 year). In India, the Central Government issues both, treasury bills and bonds or dated securities. However, State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs). G-Secs carry practically zero risk of default and, hence, are called risk-free or gilt-edged securities.

Types of Government Bonds

The government bonds come in the following different types.

• There are fixed rate bonds, where the coupon rate is fixed through the tenure of the government security.
• There are also floating rate bonds where the coupon on the bond is continuously reset on a periodic basis.
• Bonds can also be inflation indexed where the yield on the bond is continuously reset based on changing inflation equations.
• There are also bonds with call and options. Normally, call option is at the discretion of the issuer and put option is at the discretion of the investor.

Apart from these, you can also classify based on the type and tenure of the bonds. Here is how the classification can be done.

• Dated government securities are longer term fund raising securities ranging from 1 year maturity to up to 40 years maturity. The 10 year government security is normally the benchmark for government securities.
• Treasury bills are means of raising funds for the shorter term. Typically treasury bills are of 91-day maturity, 182-day maturity and of 364 day maturity. These are short term debt instruments for raising funds for under one year.
• Cash management bills or CMBs were introduced by the government in the year 2010. They have a tenure of shorter than 91 days so the funds are used to meet very short term needs of the government.

In addition, there are also state development loans and municipal bonds, but they are higher on the risk scale and we shall not get into them in detail.

The Best Government Bonds

Here, the best government bond funds are ranked based on their five year returns. Only returns are considered for the growth option on a CAGR basis in this case.

Data Source: Morningstar India

Conclusion

Government bonds have emerge as a new option for retail investors, especially with the retail direct accounts with RBI. Of course, the indirect option of investing through debt mutual funds is always there for investors.