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BINOY MEHTA (31) Government securities

Government Securities Government of India (GOI) Securities is sovereign debt obligations/instruments. They are issued by Reserve Bank of India (RBI) on behalf of the Government to finance deficit and public sector development programs. Main Types: 1) Government of India Securities issued by Government of India. 2) State Government Securities issued by the state Governments. 3) Agency Bonds issued by Government agencies or public sector undertakings wherein the principal and interest are guaranteed by the Central Government or one of the state Governments.

Government Securities are further classified in the following types: (Maturity, Denomination, which institutions can issue, what is the procedure for issue and sale such securities)
1)

Dated Securities: are generally fixed maturity and fixed coupon securities usually carrying semi-annual coupon. These are called dated securities because these are identified by their date of maturity and the coupon, e.g., 11.03% GOI 2012 is a Central Government security maturing in 2012, which carries a coupon of 11.03% payable half yearly. The key features of these securities are: a. They are issued at face value. b. Coupon or interest rate is fixed at the time of issuance, and remains constant till redemption of the security. c. The tenor of the security is also fixed. d. Interest /Coupon payment is made on a half yearly basis on its face value. e. The security is redeemed at par (face value) on its maturity date.

BINOY MEHTA (31) Government securities

1)

Zero Coupon bonds: are bonds issued at discount to face value and redeemed at par. These were issued first on January 19, 1994 and were followed by two subsequent issues in 1994-95 and 1995-96 respectively. The key features of these securities are:

a. They are issued at a discount to the face value. b. The tenor of the security is fixed. c. The securities do not carry any coupon or interest rate. The difference between the issue price (discounted price) and face value is the return on this security. d. The security is redeemed at par (face value) on its maturity date.

1) Partly Paid Stock: is stock where payment of principal amount is made in installments over a given time frame. It meets the needs of investors with regular flow of funds and the need of Government when it does not need funds immediately. The first issue of such stock of eight year maturity was made on November 15, 1994 for Rs. 2000 crore. Such stocks have been issued a few more times thereafter.

The key features of these securities are: a. They are issued at face value, but this amount is paid in installments over a specified period. b. Coupon or interest rate is fixed at the time of issuance, and remains constant till redemption of the security. c. The tenor of the security is also fixed. d. Interest /Coupon payment is made on a half yearly basis on its face value. e. The security is redeemed at par (face value) on its maturity date.

1) Floating Rate Bonds: are bonds with variable interest rate with a fixed percentage over a benchmark rate. There may be a cap and a floor rate attached thereby fixing a maximum and minimum interest rate payable on it. Floating rate bonds of four year maturity were first issued on September 29, 1995, followed by another issue on

BINOY MEHTA (31) Government securities December 5, 1995. Recently RBI issued a floating rate bond, the coupon of which is benchmarked against average yield on 364 Days Treasury Bills for last six months. The coupon is reset every six months. The key features of these securities are: a. They are issued at face value. b. Coupon or interest rate is fixed as a percentage over a predefined benchmark rate at the time of issuance. The benchmark rate may be Treasury bill rate, bank rate etc. c. Though the benchmark does not change, the rate of interest may vary according to the change in the benchmark rate till redemption of the security. The tenor of the security is also fixed. d. Interest /Coupon payment is made on a half yearly basis on its face value. e. The security is redeemed at par (face value) on its maturity date.

1) Bonds with Call/Put Option: First time in the history of Government Securities market RBI issued a bond with call and put option this year. This bond is due for redemption in 2012 and carries a coupon of 6.72%. However the bond has call and put option after five years i.e. in year 2007. In other words it means that holder of bond can sell back (put option) bond to Government in 2007 or Government can buy back (call option) bond from holder in 2007. This bond has been priced in line with 5 year bonds.

2)

Capital indexed Bonds: are bonds where interest rate is a fixed percentage over the wholesale price index. These provide investors with an effective hedge against inflation. These bonds were floated on December 29, 1997 on tap basis. They were of five year maturity with a coupon rate of 6 per cent over the wholesale price index. The principal redemption is linked to the Wholesale Price Index. The key features of these securities are: a. They are issued at face value.

BINOY MEHTA (31) Government securities b. Coupon or interest rate is fixed as a percentage over the wholesale price index at the time of issuance. Therefore the actual amount of interest paid varies according to the change in the Wholesale Price Index. c. The tenor of the security is fixed. d. Interest /Coupon payment is made on a half yearly basis on its face value. e. The principal redemption is linked to the Wholesale Price Index.

PUBLIC SECTOR BONDS VS PRIVATE SECTOR BONDS

Market Issuer Segment Government Central Securities Government State Governments Public Sector Government Bonds Agencies / Statutory Bodies Public Sector Units Private Corporates Sector Bonds Instruments Zero Coupon Bonds, Coupon Bearing Bonds, Treasury Bills, STRIPS Coupon Bearing Bonds. Investors R.B.I, Banks, insuarnce, companies, PFs, MFs,

Banks Financial Institutions

Govt. Guaranteed Bonds, Banks FIIS & Corporate, Debentures Insurance, PFs, Mfs, Individuals PSU Bonds, Debentures, Commercial Paper Debentures, Bonds, Individual, Provident funds, Commercial Paper, Insurance Co, Trusts & Mutual Floating Rate Bonds, Zero Funds Coupon Bonds, InterCorporate Deposits Certificates of Deposits, Debentures, Bonds Certificates of Deposits, Bonds

RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET

Government securities market

The evolution of the government securities market in India has been in line with the developments in other countries. Slow development of the market in the 1970s and the 1980s was shaped by the need to meet the growing financing requirements of the Government. This essentially resulted in financial repression as progressively higher statutory requirements were stipulated, mandating banks to invest in government securities at administered interest rates. Although this captive financing provided low cost resources to the Government, it impeded the development of the market and distorted the interest rate structure. Furthermore, such arrangements, along with automatic monetisation of Government deficits, hampered the conduct of monetary policy. The government securities market is at the core of financial markets in most countries. It deals with tradable debt instruments issued by the Government for meeting its financing requirements. The government securities market is also regarded as the backbone of fixed income securities markets as it provides the benchmark yield and imparts liquidity to other financial markets. The existence of an efficient government securities market is seen as an essential precursor,in particular, for development of the corporate debt market. Furthermore, the government securities market acts as a channel for integration of various segments of the domestic financial market and helps in establishing inter-linkages between the domestic and external financial markets. A market where the government securities are bought and sold is called government securities market. The securities are bonds, treasury Bills, Special Rupee securities in payment of India subscriptions in payment of India subscriptions to IMF, IBRD,ADB,IDA etc. These securities are issued by the Central Government , State Governments and Semi Governments Authorities which include local Government authorities like City corporations and Municipalities, Port trusts , State Electricity Boards Public Sector corporations and other agencies like IDBI, IFCI, NABARD, SFCS and housing boards. These Agencies are suppliers of Government securities and banks, Financial institutions and investors demand these securities in the market. Government securities offer safe avenue of investment through guaranteed payment of interest and repayment of principal by the government. They offer relatively a lower fixed rate of interest compared to interest on other securities. These Securities are issued in the denominations of Rs 100 or Rs 1000. They have Fixed maturity Period. Interest is paid Half yearly RBI service loans as these are the liabilities og Government Of India and the State Governments. THESE SECURITIES ARE SAFE AND RISK FREE . These securities are also eligible Investments. As the date of Maturity is specified in the securities they are also called dated Government Securities ". The Government Securities Market has Two Segments mainly:1. Primary Market The issuers are Central and State Governments in the Primary Market. The Securities of Central and State Government are issued in the form of Stock Certificate, Promissory notes and Bearer bonds. These securities are mainly traded at Bombay Stock Exchange. In terms of 6

RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET size, the primary market for Government Securities is much bigger than the Industrial Securities Market. 2. Secondary Market The Secondary market comprises bank, Financial Institutions, Insurance Companies, Provident Funds, Trusts, Individuals, Primary Dealers and the RBI. Different methods of sale:An auction may either be yield based or price based. 1:- Yield Based Auction: A yield based auction is generally conducted when a new Government security is issued. Investors bid in yield terms up to two decimal places (for example, 8.19 per cent, 8.20 per cent, etc.). Bids are arranged in ascending order and the cutoff yield is arrived at the yield corresponding to the notified amount of the auction. The cutoff yield is taken as the coupon rate for the security. Successful bidders are those who have bid at or below the cut-off yield. Bids which are higher than the cut-off yield are rejected. 2:- Price Based Auction: A price based auction is conducted when Government of India reissues securities issued earlier. Bidders quote in terms of price per Rs.100 of face value of the security (e.g., Rs.102.00, Rs.101.00, Rs.100.00, Rs.99.00, etc., per Rs.100/-). Bids are arranged in descending order and the successful bidders are those who have bid at or above the cut-off price. Bids which are below the cut-off price are rejected. Depending upon the method of allocation to successful bidders, auction could be classified as Uniform Price based and Multiple Price based. In a Uniform Price auction, all the successful bidders are required to pay for the allotted quantity of securities at the same rate, i.e., at the auction cut-off rate, irrespective of the rate quoted by them. On the other hand, in a Multiple Price auction, the successful bidders are required to pay for the allotted quantity of securities at the respective price / yield at which they have bid. In the example under (ii) above, if the auction was Uniform Price based, all bidders would get allotment at the cut-off price, i.e., Rs.100.20. On the other hand, if the auction was Multiple Price based, each bidder would get the allotment at the price he/ she has bid, i.e., bidder 1 at Rs.100.31, bidder 2 at Rs.100.26 and so on. 3:-Pre-announced coupon rates:(i) The coupon on such Securities will be announced before the date of floatation and the Securities will be issued at par. (ii) In case the total subscription exceeds the aggregate amount offered for sale in respect of a fixed coupon Security, the Reserve Bank of India may make partial allotment to all the applicants. (iii)The Reserve Bank of India will have the discretion to accept excess subscriptions to theextent as may be specified in the Specific Notification pertaining to the issue of the Security and make allotment of the security accordingly. (iv) Reserve Bank of India will have the discretion to accept or reject any or all applications either wholly or partially, without assigning any reason. (v) The amount of excess subscription in terms of clause (ii) of this paragraph or amount of

RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET subscription in case of rejection of application in terms of clause (iv) of this paragraph, will be refunded by the Reserve Bank of India to the respective subscribers as soon as possible and no interest will be paid on the amount so refunded. 4:-Tap sale:No aggregate amount is indicated in the notification in respect of the Securities sold on tap. Sale of such Securities may be extended to more than one day and the sale may be closed at any time during the banking hours on any day. 5:-Conversion of maturing Treasury Bills/dated securities:The holders of Treasury Bills of certain specified maturities and holders of specified dated securities are provided an option to convert the respective Treasury Bills/dated security at specified prices into new Securities offered for sale. The new Securities could be issued on an auction/pre-announced coupon basis.

RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET

TREASURY BILLS AND GOVERNMENT (GILT EDGED) SECURITIES MARKET Ownership and Maturity pattern Points to Cover - Who invests in gilt-edged securities? What is its maturity? Does it give investors any tax benefits? If yes, under which section of which act?
The government needs large amount of money to carry on its welfare activities. These activities include: Maintaining law & order, justice and national defence Central banking & monetary regulations Regulation of private sectors economic activities Creation and maintenance of physical infrastructure Government raises revenue by way of taxes and income from ownership of assets. Apart from this, it borrows money from banks, financial institutions and public to meet its expenses. One of the most important sources for government borrowing is the Government Securities Market (GSM). Government securities are risk free securities as government guarantees the payment of interest and the repayment of principal amount. They are also referred to as Gilt-edged Securities. The gilt-edged market refers to the market for Government and semi-government securities, backed by the Reserve Bank of India (RBI). Government securities are tradable debt instruments issued by the Government for meeting its financial requirements. The term gilt-edged means 'of the best quality'. This is because the Government securities do not suffer from risk of default and are highly liquid (as they can be easily sold in the market at their current price). The open market operations of the RBI are also conducted in such securities. The government securities market in India is the most dominant part of the debt market, in terms of outstanding securities, trading volume and number of participants. Features of Government Securities Government securities are sovereign debt obligations of Government of India either Central or State or any other authority of Government 9

RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET Government securities include Central government & State government securities, treasury bills and government guaranteed bonds The terms of government securities range from two to thirty years Coupons / interests offered on government securities are either pre-determined by RBI or arrived through competitive bidding or auction process Coupons are fixed and paid out semi annually to the holder of the security

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET Importance / Benefits of Government Securities Government raises short term as well as long term funds by issuing government securities It acts as a benchmark for pricing corporate papers of various maturities The government securities issues are helpful in implementing the fiscal policy of the government The working of Open Market Operations (OMO) and Statutory Liquidity Ratio (SLR) are closely connected with the changes in government securities market They are the risk free securities as payment of interest and repayment of principal amount is guaranteed by government Government securities are considered as the best collateral at the time of obtaining loans Issuers of Government Securities Central government of India State governments Semi government authorities consisting of local government authorities like Municipalities, City Corporations Autonomous institutions like Port Trusts, State Electricity Boards, Public Sector Enterprises, Metropolitan Authorities Other government authorities like IDBI, IFCI,NABARD, Housing Boards Based on the issuers these securities are classified as : Central Government Securities State Government Securities Public Sector Undertaking (PSU) BondsPrimary Issuance Process The government securities are issued as per the terms and conditions specified in the general notification of the Government and also as per the terms and conditions specified in the specific notification issued for the specific issue of each security Applicants for the issue: Firm, Company, Corporate Body, Institution, State Government, Commercial Bank, Provident Fund, Trust, FIIs registered with SEBI and approved by RBI can submit offers, including in electronic form, for purchase of government securities. The G S Act and the G S Regulations do not specify the 11

RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET eligibility criteria for investment in a G-Sec. The eligibility criteria are specified in the respective Government Notifications. Usually any person is eligible to invest in Government securities.

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET Denomination of Government Securities: 1)Central Government Securities The minimum denomination is Rs. 10000 and trading takes place in multiples of Rs. 5 crores 2) State Government Securities The minimum denomination is Rs. 1000 and trading takes place in multiples of Rs. 1-5 crores 3)Government Agency Bonds the minimum denomination is Rs. 5000 and trading takes place in its multiples Tax Benefit The Government Securities Act, 2006 (G S Act) is an Act to consolidate and amend the laws relating to Government securities and its management by the RBI and for matters connected therewith. As per clause (iv) of Section 193 of the Income Tax Act, 1961, no tax shall be deducted from any interest payable on any security of the Central Government or a State Government effective from June 1, 1997. However, as per Finance Act, 2007 and Government of India Notification No. F.4(10)-W&M/2003 dated May 31, 2007, tax has to be deducted at source on the interest exceeding Rupees ten thousand payable during a financial year on 8% Savings (Taxable) Bonds, 2003 with effect from June 1, 2007. maturity Treasury Bills Types Treasury bills (T-bills) offer short-term investment opportunities, generally up to one year. They are thus useful in managing short-term liquidity. At present, the Government of India issues three types of treasury bills through auctions, namely, 91-day, 182-day and 364-day. There are no treasury bills issued by State Governments. Amount Treasury bills are available for a minimum amount of Rs.25,000 and in multiples of Rs. 25,000. Treasury bills are issued at a discount and are redeemed at par. Treasury bills are also issued under the Market Stabilization Scheme (MSS). Auctions While 91-day T-bills are auctioned every week on Wednesdays, 182-day and 364-day T-bills are auctioned every alternate week on Wednesdays. The Reserve Bank of India issues a quarterly calendar of T-bill auctions which is available at the Banks website. (URL:http://www.rbi.org.in). It also announces the exact dates of auction, the amount to be auctioned and payment dates by issuing press releases prior to every auction. Type Day of Day of 13

RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET of T-bills 91-day Wednesday 182day 364day Wednesday week of Auction Payment* Following Friday non-reporting Following Friday Following Friday

Wednesday of reporting week

Cash Management Bills (CMBs) Government of India, in consultation with the Reserve Bank of India, has decided to issue a new short-term instrument, known as Cash Management Bills (CMBs), to meet the temporary mismatches in the cash flow of the Government. The CMBs have the generic character of T-bills but are issued for maturities less than 91 days. Dated Government Securities 1.4 Dated Government securities are long term securities and carry a fixed or floating coupon (interest rate) which is paid on the face value, payable at fixed time periods (usually half-yearly). The tenor of dated securities can be up to 30 years.

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET

TREASURY BILLS, PARTICIPANTS AND AUCTION

Definition
A Treasury bill is a negotiable debt obligation issued by a government. Treasury bills are instruments of short-term borrowing by state / central government, as the period of maturity is one year or less. They are promissory notes issued at discount and for a fixed period. They are exempt from local and state taxes. They are the safest form of marketable investment. These were first issued in India in 1917 & then in U.S in 1929

Objectives
These are issued to raise funds for meeting expenditure needs and also provide outlet for parking temporary surplus funds by investors.

Types
There are different types of treasury bills depending upon the maturity period and utility of the issuance. In India the treasury bills are issued by the Government of India only, not State Governments. The three types of treasury bills issued are 91-day, 182-day and 364-day bills (In the US, they are 52-week terms, while in India they are 364-day terms.) .They are issued through auctions.

Denominat ion
The minimum amount available is for Rs. 25,000.Treasury bills are offered in multiples of $100.They are redeemed at par and are issued at a discounted rate. Treasury bills in India are issued under the Market Stabilization Scheme (MSS) as well. Popularly known as T-bills, in the US they can be purchased in $1,000 denominations. One can purchase treasury bills amounting to a maximum of $5 million

Investors
Treasury bills can be purchased by any one (including individuals) except State govt. These are issued by RBI and sold through fortnightly or monthly auctions at varying discount rate depending upon the bids.

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET

Process
The process of issuance of treasury bills is done by bidding. The holder of the bill need not pay any fixed interest. The bill holder gets a payment on the appreciation of the bond. The bills are available for sale in the secondary market. For example, you could buy a 13-week T-bill priced at $9,700. At this point, the US government would owe you $10,000, due in three months. Thus, you are earning the difference between what you paid (the discounted value) and what the government pays you: $300. The result is the government pays a 3.09% interest rate ($300/$9,700 = 3.09%) over the tenure of three months. The payout amount is called the face value; the purchase amount is sold at a discount rate of the face value.

Auc tions
An auction is a process of buying and selling goods or services by offering them up for bid, taking bids, and then selling the item to the highest bidder.The system was introduced in 1992, for sale of dated government securities. Auctions are done online, via TreasuryDirect. The opening of Treasury Direct has enabled the online purchase and selling of T-bills. Auctions are held every Wednesday for 91-day T-bills. Auctions for the 182-day and 364day T-bills are held every other Wednesday. A calendar of T-bill actions can found on the Reserve Bank of India website along with amounts to be auctioned, dates of the auctions, and payment dates.

Participation
Provident funds can participate in all T-bill auctions either as competitive bidders or as noncompetitive bidders. Participation as non-competitive bidders would mean that provident funds need not quote the price at which they desire to buy these bills. The Reserve Bank allots bids to the noncompetitive bidders at the weighted average price of the competitive bids accepted in the auction. A competitive bid involves the buyer (bidder) setting the minimum acceptable discount rate. The bidder is not assured of receiving the desired security or desired amount.A competitive bid must be placed through a bank, a dealer, or a broker.

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET

Other features
These are highly liquid and safe investment giving attractive yield. Approved assets for SLR purposes and provide (daily) two way quotes to assure liquidity. RBI sells treasury bills on auction basis every fortnight by calling bids from banks, State Govt. and other specified bodies. Treasury bill are often regarded as risk free

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET

Prior to 1991, the Government securities market was not developed because of inefficient market practices and lack of proper institutional infrastructure. The main factor that inhibited the development of the sovereign yield curve in India in the pre-reform period was the prevalence of artificially low administrative coupon rates on these securities which were out of alignment with other interest rates in the economy. The coupon rates remained virtually unchanged up to 1979-80. Thereafter, although coupon rates were revised upwards, especially for the securities of longer tenor, the yield of a 30-year Government bond remained lower than the maximum bank deposit rate. The RBI has undertaken reforms in the Government Securities Market. The RBI has started providing liquidity support with regard to mutual funds that are dedicated exclusively to investment in Government Securities to create an enhanced and wider investor base for such securities. The support is made available to mutual funds to the extent of 20% of outstanding investment in Government Securities, either by way of outright purchase or reverse repos. Banks and selected entities are permitted to carry out Ready Forward (REPO) transactions in Government Securities. As regards to Market to Market valuation of Government Securities, the ratio of investment classified in current category for public sector banks has been raised from 40%50% and for the new private sector banks it has been fixed at 100% of their investment. With the effect from October 21, 1997 all categories of foreign Institutional Investors were allowed by the RBI to make Investment in Government Securities that are registered with and approved by the SEBI for making investments in gilt-edged securities and has been permitted up to a ceiling of 30% in debt instruments. As per amended guidelines of June,1998 equity funds were permitted to invest in dated Government Securities and Treasury Bills, both in primary and secondary markets within their 30% debt ceiling.

RECENT DEVELOPMENT

With effect from June 23, 1998, Satellite Dealers were permitted to issue commercial paper with maturity ranging from 15 days to 1 year. There were some conditions like:

1. The issue should be made within a period of 2 months of obtaining credit rating and every renewal is treated as a fresh issue. 2. The issue should be made in the multiple of Rs. 5 lakhs with a minimum of investment made by a single investor is Rs. 25 lakhs. 3. The aggregate limit is raised within 2 weeks from the date of RBI approval and the issue is not underwritten or co-accepted in any manner after 2 weeks.

A transaction in which two parties agree to sell and repurchase the same security is called ready forward contract or Repos. It is also known as buyback deal. This arrangement provides for the seller to sell specified securities with an agreement to repurchase the same at

READY FORWARD CONTRACTS (REPOS):

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET a mutually pre-determined future date and price and the buyer to purchase the securities with an agreement to resell the same at a pre-determined future date and the price. Banking finance companies like Commercial Banks, Securities Dealers, DFHI, STCI, RBI, Cooperative Banks and Non-bank finance companies like LIC, GIC, UTI and companies are allowed to participate in the repos market. Repo transactions can be used in respect of CPs, CDs, Treasury Bills and Government dated securities. National Stock Exchange can also be used for carrying out repo transactions. The Repo contract provides the seller-bank to get money by parting with its security and the buyer-bank in turn to get the security by parting with its money. The prices of sale and repurchase of securities are determined before entering into the deal. Repos, being collateralized loans, help to reduce counter party risk and fetch a low interest rate. It is possible to use repos as an effective hedge tool to arrange another repo or to sell them outright or to deliver them to another party to fulfill a delivery commitment in respect of a forward or future contract on a short sale. Repo is almost a risk-free instrument used to even out liquidity changes in the system. It offers safe short-term outlet for temporary excess cash which is close to market interest rates. Repos are used to finance securities held in trading and investment accounts of security dealers to establish short positions, to implement arbitrage activities and meeting specific customer needs because of low-risk and flexible short-term instruments. It is possible to enhance the safety of repo transaction by making the security price to the market and by providing a margin on the security value. The Repo arrangement serves as a short-term cash management tool. The RBI uses repos as a tool of liquidity control for absorbing surplus-liquidity from the banking system in a flexible way and thereby preventing interest rate arbitraging. A reverse Repo is the opposite of a repo transaction. It is a reverse purchase agreement. The counter party enters into a reverse repurchase agreement and makes a short-term collateralized loan to the bank, the primary dealer or the seller of securities. This is done by providing funds in return for holding securities on the maturity of the reverse repurchase transaction, the counter party returns the same security to the same bank and the primary dealer receives back the funds from the buyer is the principal plus interest. The interest is termed as the repo rate. This arrangement allows banks to make efficient use of their funds.

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET

PRICE AND YIELDS Gilt-edged securities are bonds issued by certain national governments. The term is of British origin, and originally referred to the debt securities issued by the Bank of England, which had a gilt (orgilded) edge. Hence, they are known as gilt-edged securities, or gilts for short. Today the term is used in the United Kingdom as well as Ireland and some Commonwealth nations, such as South Africa and India. However when reference is made to gilts, what is generally meant is UK gilts unless otherwise specified. The data collected by the British Office for National Statistics reveal that about two-thirds of all UK gilts are held by insurance companies and pension funds.[1] Since 2009 large quantities of gilts have been created and repurchased by the Bank of England under its policy of quantitative easing. The term "gilt account" is also a term used by the Reserve Bank of India to refer to a constituent account maintained by a custodian bank for maintenance and servicing of dematerialized government securities owned by a retail customer.

Trends The most noticeable trends in the gilt market in recent years have been: a substantial and persistent decline in market yields as the currency has stabilised compared to the 1970s and more recently UK gilts are seen as a safe haven compared to certain other government bonds a decline in coupons: several gilts were issued in the 1970s with coupons of around 15% per annum, but these have now matured a decline in the number of different gilts in issue, as the policy of the government has been to issue large quantities of each gilt (around 10 billion-30 billion) to maximise liquidity in global markets an increase in the volume of issuance as the Public Sector Borrowing Requirement has increased

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET a large volume of gilts have been repurchased by central government under its quantitative easing programme

DIFFERENT TYPES OF GILTS There are four basic types of Gilt: 1)Conventional Gilt: Interest is paid half yearly on dates which are set at issue, and a final payment coincides with the final redemption date. 2) Dual-dated Gilt: Similar to a conventional Gilt but with a range of earliest and latest possible redemption dates, at the Governments discretion. 3) Index-linked Gilt: Both the interest payment and the redemption amount are adjusted in line with the Retail Prices Index. 4) Undated Gilts (Irredeemables): These have low interest rates and redemption is at the discretion of the Government. The best known of these are the War Loan Gilts. GILT PRICING Gilt pricing has two components: a quotedclean price and an accrued interestcomponent which reflects the length of time since the last interest payment went ex-dividend. This can reduce (if its before pay date) or increase the amount actually paid. Together these two components set the dirty price of the Gilt, which is the price you actually pay. YIELD There are two yields quoted to help investors judge what return theyll receive and how one Gilt compares with another. The flat yield describes your annual return in relation to the money youve invested (the price paid). It pays no attention to the redemption date or amount. GROSS YIELDS ON GOVERNMENT SECURITIES

YEAR

CENTRAL GOVERNMENT SECURITIES

STATE GOVERNMENT SECURITIES

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET

REDEMPTION YIELD

RUNNING YIELD

REDEMPTION YIELD

RUNNING YIELD

1973-74 1978-79 1984-85 1988-89

5.18 5.84 8.50 10.90

4.94 5.35 7.67 8.61

5.63 5.79 6.50 9.25

5.59 5.81 6.40 6.72

The table shows that both the gross redemption and running yields on the State and Central Government securities have increased during the period 1973-74 and 1988-89.The yield has been almost doubled during the same period.The major part of this increase has occurred in the 1980s.The increase in both the yields is higher in case of Central Government securities as compared to the state government securities.

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET

Role Of Market In Government Finance.

Gilt Edged Securities.The term government securities encompass all Bonds & T-bills issued by the Central Government, state government. These securities are normally referred to, as "gilt-edged" as repayments of principal as well as interest are totally secured by sovereign guarantee. Gilt Securities are issued by the RBI, the central bank, on behalf of the Government of India. Being sovereign paper, gilt securities carry absolutely no risk of default. Government securities are unique and important financial instruments in financial market.The techniques of open market operations and statutory liquid ratio are closely connected with the dynamics of the markets for this instruments .The issue of Government Securities help in implementing the fiscal policies of the Government.Financial institutions like commercial banks are required to maintain their secondary reserve requirement in the form of the government securities.These are secured financial instruments which guarantee the certainty of income as well as capital. There are 3 types of Central and State Government Securities 1. Stock Certificates -The physical piece of paper representing ownership in a company. Stock certificates will include information such as the number of shares owned, the date, an identification number, usually a corporate seal, and signatures. They are a bit bigger than normal piece of paper and most of them have intricate designs to discourage fraudulent replication. 2. Promissory Notes-A written, dated and signed two-party instrument containing an unconditional promise by the maker to pay a definite sum of money to a payee on demand or at a specified future date. 3. Bearer Bonds-A fixed-income instrument that is owned by whoever is holding it, rather than having a registered owner. 23

RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET Coupons representing interest payments are likely to be physically attached to the security and it is the bondholder's responsibility to submit the coupons for payment. As with registered bonds, bearer bonds are negotiable instruments with a stated maturity date and coupon interest rate.

Types Of Trading.
The RBI practices the dealing in government securities in the following manner. 1. Grooming- It is teh gradual acquisition of securities by the RBI, which are nearing maturity through the Stock Exchanges. it is done in order to facilitate redemption.The object is to keep the process of issue and redemption of Government Securities continuous and thereby facilitate availability of the securities on tap. 2. Switching - The Purchases of one security and Sale of another securities carried out by the RBI in the secondary market operations is known as Switching.it helps the banks and financial institutions to improve the yeild on their investments in securities.The RBI also fixes an annual quota for the Switch Transactions of the each institution. 3. Auctioning- It is the method of trading whereby merchants bid against one another and the securities are sold to the highest bidder..it was introduced in 1992. Under this method , a number of instruments of wide trading period are sold,ranging from 14 to 264 days . The bidders give written and sealed quotations which are restricted to notified amounts.There are 2 types- Multiple Auction and Uniform Price auction. (a) Multiple Price Auction- every bidder gets allocation according to his bid.and the issuer collect the premium from all the bidders by quoting a rate lower than the cut-off yield. (b) Uniform Price Auction-competitive bids are accepted on the basis of the minimum discounted price known as cut off price.The price is determined at the auction . the minimum price is independent of the bid prices tendered below or at at the cut-off price. Trading Mechanism1. Direct Sales- Under this method ,Public Debt effect direct sale of securities. The loan amounts are pre-specified and the dates of opening of subscription for Governmant loans are also specified. 2. SGL Account Method.- Under this method RBI records the transactions as book entires only in the Securities General Ledger(SGL). The date and value of transaction are recorded .The purchasing banker maintains a separate SGL account for each dealing with the RBI in respect of its purchases of securities .The selling banker also effects his transactions by filing out the prescribed SGL form ,which is then lodged with the RBI.it helps to the banks to know their day to day balances. Bankers Receipt- The bank selling Government Securities issues a bank receipt .there are facilities for SGL ,where physical transfer can be avoided. This is done incase of repo or ready forward transactions. it is a sale transaction,which buy back the securities at the stipulated future date at a price determined onthe date of sale transaction.Under the repo short operations are conducted by banks which sell government Securities without owning them with a view to neutralising the transaction by buying them at a later date.

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET

Secondary Market Transaction. Repo TradeA form of short-term borrowing for dealers in government securities. The dealer sells the government securities to investors, usually on an overnight basis, and buys them back the following day. For the party selling the security (and agreeing to repurchase it in the future) it is a repo; for the party on the other end of the transaction, (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement.

OTCEI. Over-The-Counter Exchange Of India.

Definition-An electronic stock exchange based in India that is comprised of small- and medium-sized firms looking to gain access to the capital markets. Like electronic exchanges in the U.S. such as the Nasdaq, there is no central place of exchange and all trading is done through electronic networks. The first electronic OTC stock exchange in India was established in 1990 to provide investors and companies with an additional way to trade and issue securities. This was the 25

RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET first exchange in India to introduce market makers, which are firms that hold shares in companies and facilitate the trading of securities by buying and selling from other participants.

Wholesale Debt Market Segment In Gilt-Edged Securities. What Is Wholesale Debt Market? -

A Segment of the Secondary Market ,where the investors are mostly Banks, Financial Institutions, the RBI, Primary Dealers, Insurance companies, Provident Funds, MFs, Corporates and FIIs.The Debt Market is today in the nature of a negotiated deal market where most of the deals take place through telephones and are reported to the Exchange for confirmation. It is therefore in the nature of a wholesale market.

Does India Has A Secondary Market?

The activities of buying and selling of securities in a secondary market are carried out through the mechanism of stock exchanges.There are at present 24 Stock Exchanges in India , recognized by the government. The first organized stock exchange was established in the year 1887 at Bombay. When the Securities Contracts(Regulation) Act was passed in 1956, only 7 stock exchanges in Bombay were recognized . There Are Three important Stock exchanges In Bombay namely the Bombay Stock Exchange(BSE) .,National Stock Exchange(NSC) and over the Counter Exchange Of India(OTCEI).

An important part of monetary management is the management of Government securities market. The government securities market, which is often the predominant segment of the overall debt market in many economies, plays a crucial role in the monetary policy transmission mechanism. The Reserve Bank of India is responsible for formulating and implementing Monetary Policy. Essentially, monetary policy deals with the use of various policy instruments for influencing the cost and availability of money in the economy. As macroeconomic conditions change, a central bank may change the choice of instruments in its monetary policy. The overall goal is to promote economic growth and ensure price stability. The Reserve Bank of India can execute it, by increasing or decreasing the supply of currency as well as interest rate, carry out open market operations, control credit and vary the reserve requirements. The management of government securities market basically depends on two factors i.e the advances made and liquidity of commercial bank so as to help the monetary policy. There are basically four main 'channels' which the RBI looks at:

IMPLICATION OF MONETARY POLICY

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET 1. Quantum channel: money supply and credit (affects real output and price level through changes in reserves money, money supply and credit aggregates). 2. Interest rate channel. 3. Exchange rate channel (linked to the currency). 4. Asset price. The Reserve Bank of India plays a special and active role in the purchase and sale of these securities as a part of its monetary management exercise. There is no underwriting or guaranteeing required in the sale of government securities, as RBI is policy-bound to buy a substantial portion of the loan un-subscribed by the public. Dealing in the government securities takes place through mechanism provided by the RBI. The brokers and the dealers including banks approved by RBI are eligible to deal in these securities. The size of market borrowing has an impact on the interest rates as large-scale pre-emption of resources by the governments puts pressure on liquidity in the market and as a result interest rates tend to go up. As the size of debt is a function of macro-economic policy there is an ongoing dialogue between RBI and the Government on the issue. However, RBI's exclusive role becomes important in the matter of short-term liquidity management in the financial system. World over, central banks operate in the short-term market to influence liquidity conditions so that short-term interest rates, which instantaneously react to the volatile liquidity conditions, do not unduly impact the medium and long-term interest rates in the economy. RBI acts as a the Governments Debt Manager. In this role, it sets policies in consultation with the government and determine the operational aspects of raising money to help the government finance its requirements like Determine the size, tenure and nature (fixed or floating rate)of the loan , Define the issuing process including holding of auctions , Inform the public and potential investors about upcoming government loan auctions. The another function of RBI is it undertakes market development efforts, including enhanced secondary market trading and settlement mechanisms, authorisation of primary dealers and improved transparency of issuing process to increase investor confidence, with the objective of broadening and deepening the government securities market. Reserve Bank of India plays an important in Developing the market for government securities to enable the government to raise debt at a reasonable cost, provide benchmarks for raising resources by other entities and facilitate transmission of monetary policy actions. RBI also perform the function of Managing credit expansion: CRR and OMO reduce liquidity in the system and reduce the ability of banks to create credit. RBI also controls sector specific expansion of credit by specifying maximum amounts that can be lent, minimum margins to be maintained and higher risk weights.When RBI feels that banks have overextended themselves to certain sectors, the flow of credit to certain sectors is leading to an imbalanced growth of the economy or it wants to control the price of certain commodities by preventing hoarding by wholesalers with borrowed funds, RBI makes sector specific or commodity specific interventions.

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET RBI, as a banker to the government, helps government to borrow from the market by selling their securities. RBI also determines the timing, size, and rate paid on the issues. Rates offered by RBI on government securities are both a reflection of the market and also an indicator to the market on the direction of interest rate movements. To maintain favorable conditions in the government securities market it also requires the rejection of the traditional monetary policy which is basically depended on bank rate variation to influence economic activity. In the free market it is found that variation in the bank rate ought to cause variation in interest rate on the government securities and its prices. The RBI have been holding only central government securities as a matter of policy. The government securities held by the RBI are partly held in the form of assets of the issue department and partly in banking department. The securities held in the banking department are available for sale in open market operations by RBI. RBI uses government securities in their open market transactions, although to varying degrees. More specifically, they use outright or repo transactions with these securities to add or drain reserves from the system. The extent to which these assets are used depends, among other factors, on the design of the operational framework of monetary policy.

F.No 4(9)-W&M/2000: Government of India, in supersession of Notification F.No. 4(2)W&M/97 dated 1st April 1997 issued by Government of India as amended by the Government of India notification F.No. 4(7)-W&M/99 dated 5th April 1999, hereby notifies that issue of Government Securities (hereinafter referred to as "Securities") hereafter will be subject to terms and conditions spelt out in this notification (called the `General Notification') as also terms and conditions notified separately in the Specific notification issued in respect of each security issue until further notice. The objective of the General Notification has been to list out the general terms and conditions applicable to issues of Government Securities and the features and methods of issue of different types of Government Securities. The Specific Notification issued from time to time in respect of each security issue will supplement the General Notification and cover specific features pertaining to the particular security issue. Explanation For the purpose of this paragraph 'Specific Notification' means the notification to be issued by Government of India announcing issue of any particular Government Security. The Government Securities (G-Sec) market is the oldest and the largest component of the Indian Debt Market in terms of market capitalization, outstanding securities and trading volumes. The Reserve Bank of India manages public debt and issues Indian currency denominated loans on behalf of the central and the state governments under the powers derived from the Reserve Bank of India Act. The RBI is the debt manager for both the 28

Volume and composition of issues

RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET Central Government and the State Governments. It is also the regulator of Government securities market. The Public Debt Act, 1944, provides the framework under which government securities are issued and serviced. Under the RBI Act, 1934, RBI is the manager of Central Government debt by statute. RBI manages the debt of state governments on the basis of separate agreements. External debt of the Government is managed by the Ministry of Finance. As a debt manager for the both Central and State Governments, RBI in consultation with the Government, manages the maturity profile, timing of issue, composition of debt and the type of instruments issued. Operationally, RBI deals with the issue, servicing and repayment of government debt.

Volume of Trading:
There is an active secondary market in Government securities. The securities can be bought / sold in the secondary market either (i) Over the Counter (OTC) or (ii) through the Negotiated Dealing System (NDS) or (iii) the Negotiated Dealing System-Order Matching (NDS-OM). i. Over the Counter (OTC)/ Telephone Market In this market, a participant, who wants to buy or sell a government security, may contact a bank / Primary Dealer / financial institution either directly or through a broker registered with SEBI and negotiate for a certain amount of a particular security at a certain price. Such negotiations are usually done on telephone and a deal may be struck if both counterparties agree on the amount and rate. In the case of a buyer, like an urban co-operative bank wishing to buy a security, the bank's dealer (who is authorized by the bank to undertake transactions in Government Securities) may get in touch with other market participants over telephone and obtain quotes. Should a deal be struck, the bank should record the details of the trade in a deal slip (specimen given at Annex 3) and send a trade confirmation to the counterparty. The dealer must exercise due diligence with regard to the price quoted by verifying with available sources (See question number 14 for information on ascertaining the price of Government securities). All trades undertaken in OTC market are reported on the secondary market module of the NDS, the details of which are given under the question number 15. ii. Negotiated Dealing System The Negotiated Dealing System (NDS) for electronic dealing and reporting of transactions in government securities was introduced in February 2002. It facilitates the members to submit electronically, bids or applications for primary issuance of Government Securities when auctions are conducted. NDS also provides an interface to the Securities Settlement System (SSS) of the Public Debt Office, RBI, Mumbai thereby facilitating settlement of transactions in Government Securities (both outright and repos) conducted in the secondary market. Membership to the NDS is restricted to members holding SGL and/or Current Account with the RBI, Mumbai. In August, 2005, RBI introduced an anonymous screen based order matching module on NDS, called NDS-OM. This is an order driven electronic system, where the participants can trade anonymously by placing their orders on the system or accepting the orders already placed by other participants. NDS-OM is operated by the Clearing Corporation of India Ltd. (CCIL) on behalf of the RBI (Please see answer to the question no.19 about CCIL). Direct access to the NDS-OM system is currently available only to select financial institutions like Commercial Banks, Primary Dealers, Insurance Companies, Mutual Funds, etc. Other participants can access this system through their custodians, i.e., with whom they maintain Gilt Accounts. The custodians place the orders on behalf of their customers like the urban co-

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RUSHAB MEHTA (32) GOVERNMENT SECURITIES MARKET operative banks. The advantages of NDS-OM are price transparency and better price discovery. Gilt Account holders have been given indirect access to NDS through custodian institutions. A member (who has the direct access) can report on the NDS the transaction of a Gilt Account holder in government securities. Similarly, Gilt Account holders have also been given indirect access to NDS-OM through the custodians. However, currently two gilt account holders of the same custodian are not permitted to undertake repo transactions between themselves. iii. Stock Exchanges Facilities are also available for trading in Government securities on stock exchanges (NSE, BSE) which cater to the needs of retail investors.

Historical growth chart

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