Deciphering the new way of investing in G-sec

Are you a retail investor who has felt the lack of long term options to park your debt money safely? Then you may see an opportunity in the new avenues opening up to give options to retailers to invest in government bonds.

After opening an account to participate in government securities through your NSE goBID stockbroker or the latest RBI Retail Direct platform, how should you participate in the market?

We demystify the world of government bonds.

What is on the menu

Just like in the stock market, the government bond market is classified into the primary and secondary segments. Unlike various corporate promoters who sell shares through IPOs, there is only one authorized seller for new government bond issues – the Reserve Bank of India. The RBI conducts periodic auctions of government securities in which institutions such as banks, insurance companies and provident funds participate. Retail investors can purchase G-sec in these auctions through non-competitive offers under a special quota, subject to a minimum of 10,000 and a maximum of ₹ 2 crore.

The main instruments available are Indian Government Treasury Bills (Treasury Bills), Indian Government Dated Securities (G-sec), Gold Sovereign Bonds (SGB) and Government Development Loans (SDL) . Treasury bills are issued when the central government wishes to borrow for periods of 91 days, 182 days and 364 days. Dated G-sec and SDL are issued for terms of 1 to 40 years.

How Primary Auctions Work

Unlike IPOs, which can happen at any time, RBI’s main auctions follow a specific schedule, so you can plan your purchases well in advance. For dated G-secs, RBI publishes its auction schedule six months in advance here: https://tinyurl.com/rbigsecs You can find its quarterly schedule for Treasury bill auctions here: https: // tinyurl.com/rbitbills

Once you log into your G-sec trading platform, you are presented with a list of government securities currently up for auction.

Treasury bills are offered for less than their face value which represents the return you get. If a 182-day Treasury bill with a face value of 100 is offered at 98, your yield is 4.09% (2/98 * 365/182). But G-sec auctions can be yield-based or price-based. New G-sec are typically issued through yield-based auctions, where investors bid on the basis of the coupon rate they wish to demand from the government. The lowest coupon to which an auction is fully subscribed is considered the cutoff yield and becomes the bond’s interest rate. The RBI also holds price-based auctions when it re-issues older G-sec. In competitive bidding, all institutions that bid below the threshold yield or above the threshold price for bag allocations.

As a retail investor, you are required to bid at institutionally determined yield / cut-off prices and you will receive bonds at the weighted average price that emerges from the tenders.

If the weighted average price is above the cutoff rate, you may need to shell out a little more than face value to acquire your G-sec, which is seen as the excess markup.

The workings of the Retail Direct Gilt account

Secondary market negotiations

CCIL’s Negotiated Dealing System Order Matching or NDS-OM is the platform on which government bond secondary market trading takes place. Even telephone conversations are captured here. So, this is the platform you need to log into to get information on the latest market stocks, government bond prices and liquidity.

NDS-OM offers two segments: a regular market segment and an odd lot segment. As the minimum lot size for trading in the regular market is 5 crore, it is the odd lot segment (trades below ₹ 5 crore) that is essential for retail investors looking to get into G- dry.

Just as you can follow live market quotes for the stocks you are looking to buy on BSE or NSE, you can follow live market quotes for G-sec, Treasuries and SDL on NDS-OM during market hours here: https: // tinyurl.com/ccilindia

To buy and sell securities, you must first understand the nomenclature used. Central government bonds are described using their coupon rate and year of maturity. The current 10-year central government bond is described as 0610GS2031 – 6.10 percent is the coupon rate and 2031 is the maturity year. While fixed rate bonds are described using their coupon rates, floating rate bonds are simply described as FRBs. Treasury bills follow a slightly different nomenclature, with their content (not the coupon) appearing in their description. For example, 091DTB17022022 is the 91-day Treasury bill maturing February 17, 2022. The descriptions of SDLs contain additional information about the states that issue them.

The NDS-OM home page lists all the securities traded for the day, with open / high / low, last traded price (LTP) and last traded yield (LTY), as well as booklets individual orders. Securities that are actively traded in the regular market may not trade on Odd Lots and prices and returns may vary between the two.

What to consider

When choosing which government bonds to invest in, three factors should be considered in the decision.

1 Mandate

The length or period of maturity has a big influence on the returns you get from a bond. So how do you decide to buy a 91-day Treasury bill or a 20-year G-sec? Well, you can base this decision on three variables.

First, you can simply match the duration of the obligation to your financial goal. If you’re looking to save on planned spending 3 months from now, a 91-day T-bill is right for you. If you’re looking to park some money for your retirement, a 20-year-old G-sec may do the trick.

Second, your choice should depend on whether you expect market interest rates to rise or fall from there. When interest rates rise, the prices of older bonds can fall as buyers rush to buy newer bonds with better coupons. The longer the term of a bond, the more sensitive it is to rate hikes. Interest rates, like the Sensex, move in cycles. To assess whether market interest rates are high or low, it is useful to refer to historical trends in the RBI reverse repo rate and the yield in the 10-year government bond market.

Over the past 20 years, RBI repo rates have ranged from 4% to 8%, and the 10-year G-sec has hovered between 5.8% and 9.1%. Today, with the repo rate at 4% and the 10-year G-sec at 6.3%, we are clearly approaching the bottom of this range. This makes short term bonds more attractive than long term bonds.

Third, you can consider the shape of the yield curve to decide on the tenure. Usually, extending the term of your bond carries a higher risk (because rates can rise and the buyer can default). Therefore, it makes sense to prefer, say, a 20-year bond over a 10-year bond only if the former offers a much higher yield than the latter. Today, for example, while a 364-day T-bill offers a yield of 4.03%, the 3-year G-sec offers 5.09%, the 5-year G-sec 5.68%. and the G-sec at 10 years. sec 6.36 percent. Essentially, even if you earn 106 basis points more in interest by going for a 3-year term instead of a year, there is only a 59 basis point advantage in extending your term from 3 to 5 years. To minimize the risk, you may prefer the 3 year.

2 Type of deposit

While there isn’t much to choose from between a Treasury bill and a G-sec, as both are issued by the Center, you need to be more selective when going for SDLs. The price of SDLs is usually based on the financial data of the issuing state, after taking into account variables such as its latest budget and revenue deficit, its ability to increase tax revenue, and its plans for borrowing. If you are unsure of doing this homework, the mutual fund route to participating in SDLs is better.

3 Liquidity control

Unlike stocks, Indian government bonds do not offer high liquidity in the secondary market, especially for investors in the odd lot segment. Therefore, while buying government bonds, it pays to be prepared to hold them to maturity (which also helps avoid interest rate risk). If you plan to exit earlier, you should check the number of trades and the total amount traded for the bond on NDS-OM. Typically, the most recently issued 10-year, 5-year and 3-year G-secs represent 70-80% of transactions in volume and value. Treasury bills and SDLs have much lower trading volumes than long-term G-sec. Decreasing time can also reduce liquidity. You can find a list of all outstanding government bonds, whether traded or not, here: https://tinyurl.com/govtbonds. Bonds with a higher amount outstanding are likely to be more liquid.

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