A government bond is a type of debt instrument issued by a central or state government. These bonds are issued to meet the liquidity requirements of the government. These bonds guarantee interest return to the investor along with principal repayment at the time of maturity. They come with certain different maturities.
Government Bonds India
Government bonds in India are issued under the category of government securities. These are issued for both long term and short term maturity period. The shortest maturity period of government bonds is 91 days for T-bills and the longest maturity period can be 40 years. The interest rate also varies with the maturity period. The longer the maturity, the higher will be the interest rate and vice versa.
Types of Government Bonds of India
There are several different types of government bonds issued in India:
1. Treasury Bill
Treasury bills are also known as T-bills. These bonds are issued for different maturities within a period of 1 year. T-Bills have 3 different maturities i.e. 91 days, 182 days and 364 days. T-bill investors do not receive interest or coupon payments, but are issued a discount on their face value. Investors earn from the difference between the face value and the discounted value.
2. Cash Management Bill
These are very similar to T-bills. Cash management bills are also short-term securities that are highly flexible. These bills are issued with a maturity period of less than 91 days.
3. Fixed Rate Bonds
It is a bond that is issued with a fixed coupon rate throughout the tenure of the bond. We can also say that the interest rate remains the same irrespective of the fluctuations in the market rates.
4. Floating Rate Bonds
As the name suggests, these bonds carry a floating interest rate during the tenure of the bond. The interest rate of the bond varies from time to time after a fixed periodic interval of issuance.
5. Zero-coupon bonds
Zero-coupon bonds do not have a coupon rate. The investor of these bonds does not earn interest. They make profit from the difference between the issue price and the redemption price. Zero-coupon bonds are issued at a discount and are withdrawn at equivalence.
6. Capital Index Bonds
Bonds in which the amount invested is linked with the accepted index of inflation. Capital index bonds are issued to protect investor’s invested or principal amount from inflation.
7. Inflation Index Bonds
Inflation index bonds are bonds in which the amount invested and interest payments are linked to an inflation index. That is, the Consumer Price Index or the Wholesale Price Index are inflationary indices. The actual returns from these bonds remain constant during the tenure.
8. Bonds with Call or Put Options
Bonds are issued with a Call option or a Put option. A Call option gives the issuer the right to buy back the bond, while a Put option gives the investor the right to sell the bond to the issuer. Generally, these options are available to the investor and the issuer only after 5 years from the date of issue.
9. Sovereign Gold Bond
These are bonds whose price is linked to the price of gold. Sovereign Gold Bonds (SGBs) are issued by the central government. The issuer invests in gold and in these bonds the investor has the opportunity to take exposure to gold, without the burden of holding physical gold. The face value of these bonds is calculated from the simple average value of 99.99% purity of gold. The price list is published by India Bullion & Jewelers Association Limited. One gram of gold is the denomination of sovereign gold bonds. The interest earned from these bonds is exempt from income tax.
10. Capital Gains Bonds:
These bonds are also called Section 54EC bonds. These bonds give an investor tax exemption under Section 54EC of the Income Tax Act. Capital gains bonds help save on long-term capital gains tax on the sale of assets. This includes bonds issued by the National Highways Authority of India (NHAI) or Rural Electrification Corporation (REC).
11. Tax-Exempt Bonds:
These bonds are issued by the government to raise funds for a specific purpose. Examples of tax-exempt bonds can be bonds issued by municipal bodies. As the name of the bond says, they offer tax exemption to the investors under Section 10 of the Income Tax Act, 1961.
State Development Loans or SDLs are dated bonds that are issued by the state government to meet its borrowing requirements. There is a prescribed limit for every state for borrowing through SDL. The main objective of SDL is to meet the budgetary needs of the government of a state.
Advantages of Government Bonds
Government bonds are considered risk-free bonds as they are issued by the Government of India. Bonds promise the investor interest income and returns and stability of the investment amount. These bonds are suitable for the investor who is looking for an investment option with low or no risk and fixed returns.
Government bonds offer a fixed interest rate. The interest rate offered is good as compared to regular savings account but only if the bond has a maturity period.
Government bonds are also traded in the market. It gives liquidity to the investor to buy or sell the bond to any other investor anytime as per his requirements.
Disadvantages of Government Bonds
1. Less Returns
The return of government bonds is very low compared to other investment opportunities. The short-term bond amount/return is sometimes less than the interest on a regular savings account.
2. Interest Rate Risk
Long-term government bonds carry interest rate risk. If inflation rises, the interest rate in the economy will also increase, hence its market value will decrease.
Who should invest in government bonds?
Government bonds are one of the safest investment options. These bonds are best suited for investors who are looking for investment options with very low risk and stable returns. Government bonds can be used to reduce the market risk of an investor’s portfolio.
Investors who want to invest to diversify their portfolio can invest in government bonds. Government bonds are also known as fixed income instruments.
Frequently Asked Questions
What are government bonds?
Bonds issued by the state or central government are called government bonds. These bonds pay a fixed coupon or interest rate. Government bonds come with a fixed maturity which varies from 91 days to 40 years. There are many types of these bonds and each type comes with different features.
What is Bond Result/Yield?
The return or interest paid against the bond is known as the bond yield. The issuer of the bond pays the investor interest or yield on the principal amount. A very simple way to calculate a bond yield is to divide the coupon rate by the face value of the bond.
What are the different types of government bonds?
There are many different types of government bonds in India. Some of them are:
1. Treasury Bills or T-Bills
2. Fixed Rate Bonds
3. Zero-coupon bonds
4. Inflation Index Bonds
What are the benefits of investing in government bonds?
Investing in government bonds has many advantages such as they are risk-free, offer fixed returns and good liquidity.
Is investing in government bonds safe?
Yes, government bonds are very safe as these bonds are considered risk-free. Bonds are issued by the Government of India and hence the chances of default by the Government are almost negligible. So, investing in government bonds is a safe investment.
What are the disadvantages of investing in government bonds?
Investing in government bonds has several disadvantages such as very low interest rate or yield of bonds and interest rate risk in bonds.