Government Securities are considered the safest form of investment as they are backed by the government. The returns from government securities are generally low compared to other investment options due to their low risk. The returns on government securities are usually in the form of interest payments or capital appreciation.
The interest rate on government securities is determined by the market demand and supply dynamics, inflation expectations, and the government’s fiscal policies. The central bank of a country also plays a role in setting the interest rates on government securities through its monetary policy.
The two main types of government securities are treasury bills and government bonds. Treasury bills are short-term government securities with a maturity of up to one year, while government bonds have longer maturities ranging from two years to 30 years.
The returns from government securities can be calculated using various measures such as current yield, yield to maturity (YTM), and yield to call (YTC).
Current Yield: The current yield is the annual interest payment divided by the current market price of the security. For example, if a government bond has a face value of $1000, a coupon rate of 5%, and a current market price of $900, the current yield would be calculated as follows:
Current Yield = Annual Interest Payment / Current Market Price
Annual Interest Payment = Face Value * Coupon Rate
= $1000 * 5%
= $50
Current Yield = $50 / $900 = 5.56%
Yield to Maturity (YTM): The yield to maturity is the total return that an investor can expect to earn on a government security if held until maturity. The YTM takes into account the annual interest payments and any capital gains or losses that may occur if the security is sold before maturity.
The YTM is calculated using the following formula:
YTM = (C + (F – P) / n) / ((F + P) / 2)
Where:
C = Annual coupon payment
F = Face value of the security
P = Current market price of the security
n = Number of years to maturity
For example, if a government bond has a face value of $1000, a coupon rate of 5%, and a current market price of $900 with a maturity of 5 years, the YTM would be calculated as follows:
YTM = ($50 + ($1000 – $900) / 5) / (($1000 + $900) / 2) = 7.16%
Yield to Call (YTC): The yield to call is similar to the YTM, but it takes into account the possibility that the security may be called or redeemed by the issuer before its maturity date. The YTC is the yield that an investor would earn if the security is called on the first call date.
The YTC is calculated using the following formula:
YTC = (C + (F – P) / n) / ((F + P) / 2)
Where:
C = Annual coupon payment
F = Face value of the security
P = Current market price of the security
n = Number of years to the first call date
For example, if a government bond has a face value of $1000, a coupon rate of 5%, and a current market price of $900 with a call date of 2 years, the YTC would be calculated as follows:
YTC = ($50 + ($1000 – $900) / 2) / (($1000 + $900) / 2) = 10.17%
In summary, the returns from government securities are generally low due to their low risk. The returns can be calculated using various measures such as current yield, yield to maturity, and yield to call.
Types of Government Securities:
1. Treasury Bills (T-Bills)
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Short-term government securities with maturities of 91 days, 182 days, or 364 days.
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Issued at a discount and redeemed at face value.
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No interest payments; profit is the difference between purchase price and face value.
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Ideal for risk-averse investors seeking short-term parking of funds.
2. Dated Government Securities (G-Secs)
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Long-term securities with maturities ranging from 5 to 40 years.
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Carry a fixed or floating coupon rate, paid semi-annually.
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Examples: 7.26% GS 2033 (7.26% interest maturing in 2033).
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Commonly used by RBI for monetary operations.
3. Cash Management Bills (CMBs):
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Very short-term instruments (less than 91 days), used to manage temporary liquidity mismatches.
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Similar to T-Bills but with flexible maturity and amounts.
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Issued by the Government of India on the advice of the RBI.
4. State Development Loans (SDLs):
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Issued by state governments to meet their budgetary requirements.
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Similar to dated G-Secs, but issued by individual states.
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Typically carry slightly higher yields than central government securities.
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Backed by the respective state government, not the central government.
5. Sovereign Gold Bonds (SGBs):
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Issued by the Government of India, linked to the price of gold.
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Offers 2.5% annual interest plus capital appreciation equivalent to gold price movement.
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Held in demat or certificate form; a substitute for physical gold investment.
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Maturity period: 8 years with exit option after 5 years.
6. Floating Rate Bonds (FRBs):
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Interest rates on these securities change periodically based on a reference rate.
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Helps investors during rising interest rate environments.
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Periodic coupon reset makes them less sensitive to market volatility.
7. Inflation-Indexed Bonds (IIBs):
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Principal and interest payments are linked to inflation (such as WPI or CPI).
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Protects investors’ real returns during inflationary periods.
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Not widely popular in India due to complexity and lower liquidity.
8. Special Securities (e.g., Oil Bonds, UDAY Bonds):
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Issued to specific entities like oil companies, FCI, or state power discoms in lieu of cash.
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Not normally traded in the secondary market.
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Used to meet specific fiscal obligations without immediate cash outflow.
