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What are Government Bonds-Types, Advantages and Disadvantages, Who should invest

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Manish Kothari
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Government Bonds

What are Government Bonds?

Government Bonds are a type of debt instrument which are issued by the central or state government. These bonds are issued to meet the liquidity requirements of the government. These bonds guarantee the interest return to the investor along with the principal repayment at the time of maturity. They come with fixed 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 periods. The shortest maturity period of the government bonds is 91 days for T-bills and the longest maturity 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 many different types of Government bonds that are issued in India:

  1. Treasury Bills

Treasury bills are also known as T-bills. These bonds are issued for different maturity periods within 1 year duration.  There are 3 different maturities of T-bills i.e. 91 days, 182 days, and 364 days. T-bills investors do not get the interest or coupon payments, rather they are issued at discount to their face value. The investors earn from the difference between the face value and the discounted value.

2. Cash Management Bills

These are very similar to the 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 in the whole 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 implies, these bonds have a floating interest rate during the tenure of bonds. The interest rate of the bonds keeps on changing after the fixed periodic intervals decided at the time bonds are issued.

5. Zero-coupon bonds

Zero-coupon bonds do not have a coupon rate. The investor of these bonds does not earn interest. They earn profit from the difference in the issue price and redemption price. Zero-coupon bonds are issued at a discount and redeemed at par.

6. Capital Index bonds

The bonds in which the invested amount is linked with an accepted index of inflation. Capital index bonds are issued to protect the invested or principal amount of investors from inflation.

7. Inflation index bonds

Inflation index bonds are those bonds in which the invested amount and the interest payments are linked to an inflation index. Namely, the Consumer Price Index or Wholesale Price Index are the inflation indices. The real return from these bonds remains constant during the tenure. 

8. Bonds with Call or Put option

The bonds are issued with the call option or put option. The call option gives the right to the issuer to buy back the bond while a put option gives the right to the investor to sell the bonds to the issuer. Generally, these options are also only available to the investor and issuer after 5 years from the date of issue.

9. Sovereign Gold Bonds

These are the bonds that have their price linked to the price of gold. Sovereign Gold Bonds(SGBs) are issued by the central government. The issuer invests in the gold and the investor in these bonds have the opportunity to take exposures in gold without having the burden of holding physical gold. The nominal value of these bonds is calculated by the simple average of the closing price of 99.99% purity of gold. The price list is published by the India Bullion and Jewellers Association Limited. One gram of gold is the denomination of sovereign gold bonds. The interest earned from these bonds is exempted from the income tax.

10. Capital Gain Bonds

These bonds are also called Section 54EC Bonds. These bonds give the tax exemption under Section 54EC of the Income Tax Act to an investor. Capital gain bonds help to save the long-term capital gain tax on the sale of property. It comprises bonds issued by the National Highway Authority of India (NHAI) or Rural Electrification Corporation (REC).

11. Tax-Free Bonds

These bonds are issued by the government to raise the funds for any specific purpose. Examples of tax-free bonds can be the bonds issued by the municipal body. As the name of the bond says, they give the tax exemption to investors under Section 10 of the Income Tax Act, 1961. 

12. SDLs

State Development Loans or SDLs are the dated bonds that are issued by the state government to meet their borrowing requirements. There is a set limit for every state to borrow through SDLs. The main purpose of the SDLs is to meet the budgetary needs of the government of a state.

Advantages of Government Bonds

  1. Risk-free

Government bonds are considered risk-free bonds as these are issued by the government of India. The bonds promise the returns and stability of the interest income and investment amount to the investor. These bonds are suitable for the investor who is looking for an investment option with low or no risk and fixed returns.

2. Returns

Government bonds offer a fixed rate of interest. The interest rate offered is good in comparison with the regular savings account but only if the bond has longer maturity. 

3. Liquidity

Government bonds are also traded in the market. It gives the liquidity to the investor to anytime buy or sell the bonds to another investor as per their requirements.

Disadvantages of Government Bonds

1. Low returns

Government bonds yield is very low in comparison with other investment opportunities. Short-term bond yield is sometimes lower than the interest on a regular saving account.

2. Interest rate risk

Long-term government bonds have an interest rate risk. If inflation rises, the interest rate in the economy will also rise and so the bond will lose its value in the market & vice versa.

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 the portfolio of an investor. 

The investor who is seeking to invest in a way to diversify or dilute their portfolio can invest in government bonds. Government bonds are also known as fixed-income instruments. 

Frequently Asked Questions (FAQs)

  • What are government bonds?

The bonds which are issued by the state or central government are called government bonds. These bonds give a fixed coupon or interest rate. Government bonds come with a fixed maturity which varies from 91 days to 40 years. These bonds are of many types and every type comes with different features.

  • What is the bond yield?

The return or interest which is offered against the bond is known as the bond yield. The issuer of the bond pays the interest or the yield on the principal amount to the investor. There is a very simple way to calculate the 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 bond
  3. Zero-coupon bond
  4. Inflation index bond
  • What are the advantages of investing in government bonds?

There are many advantages of investing in government bonds like they are risk-free, offer fixed returns, and good liquidity.

  • Is investment in government bonds safe?

Yes, the government bonds are very safe as these bonds are considered risk-free. The bonds are issued by the government of India and hence the chances of default by a government is almost negligible. So, investment in government bonds is a safe investment.

  • What are the disadvantages of investing in government bonds?

There are many disadvantages of investing in government bonds like the interest rate or the yield of the bonds is very low and the bonds have the interest rate risk.

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