Government Securities: Meaning, Types and Risks

Government Securities: Meaning, Types and Risks | Overview

• Reason for Issuing Government Securities
• Benefits of Government Securities/ Bonds
• Risks Attached to Government Bonds/ Securities
• Internal Securities
• External Securities

This article discusses the meaning of government securities. When the government itself issues any traditional instrument or bonds with a guarantee that the principal amount in addition to the periodic interest payments will be repaid as soon as the securities get matures, such bonds or instruments are known as government securities.

It is used as a means for acknowledging the debt obligation of the government. National debts, public debts and sovereign debts are some of the names which are used for referring the government securities.

These government securities are normally issued in the currency of that particular country. The government sells these securities which are usually based on the creditworthy rate of the security as determined by the market.

REASON FOR ISSUING GOVERNMENT SECURITIES

There are three main reasons for getting securities issued by the government. These are as follows:

1. For the economic development of the country,
2. For raising funds to meet the expenditures at the end of government, and
3. For getting control over the supply of money in the economy of the country.

BENEFITS OF GOVERNMENT SECURITIES/ BONDS

• These government bonds provide the return for the securities in the form of interest (coupons). The maximum amount of safety is offered by the securities that are issued by the government because they are the commitment of sovereign in terms of repayment of principal and payment of interest.
• The requirement of keeping the securities safe is obviated by them as the government bonds can also be held in the form of book-entry viz., scriptless or dematerialized form.
• There is a wide range of securities present in the market varying as per the maturity period minimum of 9 days and a maximum of 30 years, which may suit the duration of the bank’s liability.
• The secondary market provides the platform to trade in the government securities easily to meet the requirement of cash.
• Government securities also act as collateral for borrowing funds in the repo market.
• There is a settlement system that is used for trading in the securities issued by the government. Such a system finds its basis on Delivery Versus Payment (DVP), which is a very efficient, safe and simple form of settlement. The mechanism provided with the help of Delivery Versus Payment ensures the transfer of funds from the side of buyer simultaneously with the transfer of securities from the end of a seller of the securities, thereby reducing the risk of settlement.
• Prices of government securities are readily available because of the presence of a secondary market which is active and liquid in nature. In addition to it, a mechanism for dissemination of prices that are transparent in nature is also made readily available to the players of the market.
• There are various investors present in the market. Large investors include insurance companies, banks while provident funds, cooperative banks and regional rural banks form part of the smaller investors. It is a requirement for both the types of investors to hold those securities that are issued by the government.

RISKS ATTACHED TO GOVERNMENT BONDS/ SECURITIES

Not only benefits are attached to the government bonds but there are various risks as well to such securities. These risks are as follows:

• Credit Risk

Securities that are issued by Government are denominated in the country’s own currency. Sometimes, it is assumed as the approximation of those securities which are free from all kinds of risks. This is so because of the assumption that additional currency is created or taxes can be raised by the government to get the bonds redeemed at the time of maturity.

For instance, it was noted that in 1998 the Russian government had become defaulter on the debt of its own domestic currency, which is known as the Ruble Crisis.

A state that is politically unstable is a risk- free state. This is so because it is sovereign and thus, in the capacity to cease the payment. There are many instances of this type of phenomenon which were reported in Spain in the 16^th and 17^th centuries when the debt of the government was nullified seven times during a century. Another instance was reported in 1917 during the revolution of Russia when the liability of Imperial Russia was denied to be accepted.

• Currency Risk

Currency risk is that type of risk which will lead to the downfall of the value of currency paid by a bond in comparison to the reference currency provided by the holder.

For instance, a French investor will find more currency risk in the securities denominated in the US dollar instead of the French euro. Similarly, a US investor will find more currency risk in the securities denominated in the French euro instead of the US dollar. A bond that is denominated by such a currency that has no history of keeping its value stable may not prove to be a good deal even if it offers a very high rate of interest.

• Inflation risk

The risk associated with the decline in the value of the currency paid by a bond of government during the time of maturity is known as inflation risk. Some amount of inflation is always expected by the investors and due to which the rate of inflation will be higher than expected. This is noted a lot of times in history.

For instance, it was observed that in 1920, when the government of Germany printed a huge amount of money in cash, the situation of hyperinflation was suffered by Weimar Germany which was not in a capacity to pay the national debts deriving due to the costs that were imposed during the World War I. Inflation-indexed bonds were issued by many governments that provides protection against the inflation risk to these investors by getting both the maturity payment and interest payment linked together to the index of consumer prices.

TYPES OF SECURITIES ISSUED BY GOVERNMENT

There are two broad categories to divide the securities issued by the government. They are as follows:

1. Internal securities, a loan from the general public of that very country
2. External securities, a loan from foreign institutions

INTERNAL SECURITIES

There are various modes to raise fund from the general public of that country. They are as follows:

• Cash Management Bills

CMBs (Cash Management Bills) are those bills which are short term in nature and issued by the central government to get its quick need of cash fulfilled. RBI issues the bills on behalf of the government. The generic character both the cash management bills and treasury bills are similar in nature but the maturity period of CMBs is less than that of 91 days. Similar to T- bills, these bills get issued at discount and at maturity, they get redeemed at face value. The temporary requirement of government for cash forms the basis to determine the date of issue, tenure and notified amount of CMBs.

RBI makes the announcement for auctioning the CMBs by calling a Press Release that gets issued before one day of the said auction. Such instruments are eligible for the ready forward facility and can be traded easily. According to the sec 24 of the Banking Regulations Act, 1948, the investment made in CMBs is also reckoned as that investment in the government bonds which is considered suitable by banks for the purposes of SLR. In May of 2010, the first set of CMBs got issued.

• Treasury Bonds (Dated Government Securities)

Dated Government Securities are securities for a long term and carry a coupon or interest rate which may be floating or fixed in nature. It gets paid on the face value of the bond and is payable at fixed intervals. The dated securities can be extended to a maximum tenure of 30 years.

There are various features of Dated Government Securities such as face value (coupon), date of maturity, name of issuer i.e. Government of India, date of issue, the minimum amount of issue (Rs. 10k), coupon payment dates (half-yearly) and so on.

Dated Securities of Governments of both the state and centre gets issued by Reserve Bank of India by conducting an auction for the same. The bank releases the notification of auction with the help of calling a press release a week prior to the auction. In addition to it, major dailies are also used as a mode to make the announcement of auction. The adequate time is provided to the investors to make plans for purchasing these securities of government through such auctions.

• Treasury Bills

It is an acronym for T- Bills. They are such instruments of the money market which are short term in nature and gets issued by the Government of India. Currently, these are issued in three tenures such as 91 days, 182 days and 364 days. They do not pay any interest and also, they do not have any coupon security. They get always redeemed at the face value at maturity. In addition to it, they get issued at a discounted price.

For instance, a treasury bill of 91 days with a face value of Rs. 100/- can get issued at a sum of Rs. 98. 20/- amounting to a discount of Rs. 1.80/- and can be redeemed at its face value i.e. Rs 100/-. The difference between the face value and the maturity value is the return to the investors.

Typically, the auction for issuing T- Bills is conducted on every Wednesday by Reserve Bank of India. While the payment for all the T- Bills which were bought is done on every Friday. The auction for 91 day T- Bills is held on every Wednesday. While the auction for 182 days and 364 days T- Bills are conducted on alternate Wednesday. An annual calendar prescribing all the dates of auction and payment is released by the Reserve Bank of India.

EXTERNAL SECURITIES

There are various modes to raise fund from the institutions established and incorporated outside India. They are as follows:

• World Bank

The establishment of World Bank OR International Bank for Reconstruction and Development (IBRD) was done on 27^th December of 1945 while its operations were started in June of 1946. The main motto behind establishing the World Bank was to provide assistance to the member countries in the reconstruction and development of their territories.

It extended the help by getting the investment of capital facilitated for all those purposes which are productive in nature that includes restoring economies and promoting private foreign investment by the mode of participation or guarantee of loans as well as other investments made by private investors. India is one of the members of the World Bank. Thus, it has the eligibility to subscribe to its shares in the World Bank.

By providing the guarantee of loans, the world bank extends its help to the business enterprises of the member countries to obtain funds from the investors of other countries. The guarantee provided by the bank helps to reduce the risk attached with the investment done in foreign countries and henceforth, it promotes such investments.

In addition to the activity of lending money, a variety of technical assistance is also rendered by world bank. The interest rate charged by the bank is very high in comparison to the return from those projects for which the loan was made available by the bank.

• International Monetary Fund

IMF was set up on 27^th December of 1945 but started to work form 1^st march of 1947. India is a member country of IMF. It provides financial aid to all its members.

A member country is eligible to buy its reserve tranche up to the full amount at any time and it is subjected only to the requirement of the balance of payment need. Moreover, it provides credit to the member countries in four tranches and each tranche is equal to the 25% of the quota of that country. A request for stand by arrangements is made to the member countries that are in excess of the limit, which is prescribed in the contents of the enlarged access policy.

There are various other institutions such as Asian Development Bank (ADB) and so on, which are present on the globe to readily provide the loans to the countries for some useful purpose that can help them to develop their economy.

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