Understanding what government bonds are including government bond rates, the forms they exist in, and the advantages and disadvantages linked with investing in the same have been examined below.
What are Government Bonds?
When considering the definition of government bonds, it is important to understand that they serve as debt instruments that have been issued by the central as well as state governments of the country. These bonds are ordinarily issued when the issuer is faced with a liquidity crisis and is in need of funds such that they can develop infrastructure.
In India, a government bond can be understood to fall under the relatively expansive category of government securities (or G-Sec). Serving as long-term investment tools they can be issued for periods that range from 5 to 40 years. Central, as well as State governments, are authorized to issue these bonds. In the case of the latter, the bonds may also be known as State Development Loans.
While G-Secs had originally been issued with the aim of targeting large investors ranging from companies to commercial banks, the government has now made provisions for government securities to be accessible to smaller investors. These include individual investors as well as cooperative banks.
Varied bonds are issued by the central and state governments which each target the varied investment objectives investors might have.
Also known as a coupon, the interest rates that govern government bonds may exist in a fixed or floating form disbursed semi-annually. Ordinarily, however, most bonds issued by the government of India are at a fixed coupon rate made available in the market.
Types of Government Bonds
There exist a wide variety of government bonds some of which have been examined below.
Fixed-rate bonds – The interest rate applicable on these government bonds is fixed for the entire tenure of the investment regardless of fluctuating market rates. The coupon on a government bond is stipulated as follows. For example, 6.5% GOI 2020 implies a rate of interest applicable on the face value amounting to 6.5%, with the government of India being the issuer and the year of maturity being 2020.
Floating rate bonds (FRBs) – These bonds are variable based on periodic changes experienced by the rate of returns. The intervals within which these changes occur are made clear prior to the bonds being issued. These bonds can also exist with the rate of interest being split into a base rate and a fixed spread. This spread is determined via auction and remains stable right up to maturity.
Sovereign Gold Bonds (SGBs) – Under this scheme, entities are allowed to invest in digitized forms of gold for an extended period of time without having to avail of gold in its physical form. Interest generated via these bonds is tax-free. The price of these bonds is tethered to the price of physical gold. Ordinarily, the nominal value of an SGB is arrived at by calculating the simple average of the closing price of gold that has a purity level of 99 percent three days prior to the issuance of the bond in question. There exist limits that are imposed on what amount of SG an individual entity may hold. Different entities have different ceiling levels applicable. Liquidity of SGBs is possible following a period of 5 years. Redemption, however, is only possible based on the date of interest disbursal.
Inflation-Indexed Bonds – Serving as a unique financial tool, the principal and interest earned on such bonds are in accordance with the inflation. Ordinarily, these bonds are issued for retail investors and are indexed in accordance with the consumer price index (or CPI) or wholesale price index (or WPI). Real returns are possible with the aid of these bonds as investments remain constant and allow investors to safeguard their portfolios in the face of varying inflation rates.
7.75% GOI Savings Bond – This government security was launched in 2018 in order to replace the 8% savings bond. The interest rate applicable here is 7.75%. The RBI stipulates that these bonds can be in the possession of individual(s) who aren’t NRIs, minors, or are a Hindu undivided family. Interest earned via these bonds is taxable as per the Income Tax Act of 1961 keeping in mind an investor’s income tax slab. Bonds are issued for a minimum amount of INR 1000 and in multiples of INR 1000 as well.
Bonds with Call or Put Option – What makes these bonds stand out is that issuers are entitled to buy back such bonds via a call option or the investor has the right to sell the same with the put option to the issuer.
Zero-Coupon Bonds – These bonds don’t earn interest. Instead, investors accrue returns via the difference that exists between the issuance price and the redemption value. They aren’t issued via auction but are created via existing securities.
Pros and Cons of Investing in Government Bonds
There exist a wide variety of advantages and disadvantages linked with investing in government bonds some of which have been examined below.
Some of the advantages of investing in government bonds include the following.
– They provide investors with a sovereign guarantee.
– They are inflation-adjusted tools and give an edge to investors.
– They provide investors with a regular stream of income.
The disadvantages associated with investing in government bonds include the following.
– Barring the 7.75% GOI Savings Bond, interest-earning on other G-Sec bonds is lower.
– Owing to the fact these bonds are issued for long periods of time, they have the potential to lose relevance over time.
Investors must read the fine print prior to investing in a given security. Government bonds serve as viable instruments as they are adjusted in accordance with inflation levels and are issued by the government themselves.