Gilt-Edged (Government) Securities Market

Government securities refer to the marketable debt issued by the government of semi-government bodies. A government security is a claim on the government. It is a totally securer financial instrument ensuring safety of both capital and income. That is why it is called gilt-edged security or stock. Central Government securities are the safest among all securities. Government securities are issues by:

Central Government
State Government
Semi-Government authorities like local government authorities, e.g., city corporations and municipalities
Autonomous institutions, such as metropolitan authorities, port trusts, development trusts, state electricity boards.
Public Sector Corporations
Other governmental agencies, such as SFCs, NABARD, LDBs, SIDCs, housing boards etc.

Characteristics of Gilt-edged Securities Market

Gilt-edged securities market is one of the oldest market in India. The market in these securities is a significant part of Indian stock market. Main characteristics of government securities market are as follows:

Supply of government securities in the market arises due to their issue by the Central, State of Local governments and other semi-government and autonomous institutions explained above.
Government securities are also held by Reserve Bank of India (RBI) for purpose and sale of these securities and using as an important instrument of monetary control.
The securities issued by government organisations are government guaranteed securities and are completely safe as regards payment of interest and repayment of principal.
Gilt-edged securities bear a fixed rate of interest which is generally lower than interest rate on other securities.
These securities have a fixed maturity period.
Interest on government securities is payable half-yearly.
Subject to the limits under the Income Tax Act, interest on these securities is exempt from income tax.
The gilt-edged market is an ‘over-the-counter’ market and each sale and purpose has to be negotiated separately.
The gilt-edged market is basically limited to institutional investors.

Forms of Central and State Government Securities

These securities can be issued in three forms:

Bearer bonds are generally not issued in India and stock certificates are not popular with investors. Most government securities are in the form of a promissory note. Of course, promissory notes of a loan can be converted into stock certificates of any other loan and vice versa.

Stock certificates have some benefits over promissory notes, such as, (i) the name of the holder of stock certificate is registered in the books of Public Debt Office (PDO) and hence these are safer, (ii) these are sent to the applicant directly by registered post by the PDO, (iii) the half-yearly interest is directly remitted to the holder by an interest warrant drawn at par on any treasury or State Bank of India branch specified by the holder or is remitted by money order, if the holder so desires, and (iv) it can be sold by singing the transfer for on the reserve of the certificate. Despite these advantages stock certificates are not popular because their lack of quick transferability and negotiability, these cannot be transferred by endorsement. The procedure for their transfer is relatively more complex.

Participants in Gilt-edged Securities Market

Participants in government securities market belong to the following categories:

Central and State governments. Their holdings represent inter-government transfer of resources.
Banking Sector, comprising commercial banks and co-operative banks.
Insurance companies including both Life Insurance Corporation and general insurance companies.
Provident funds, both statutory and non-statutory
Other institutions including special financial institutions, joint stock companies, local authorities, trusts, individuals and non-residents.

Why Government Securities are Issued?

Issue of securities takes place for the following purposes:

For refunding, i.e., for conversion or refinancing of maturing securities;
For advance refunding of securities which have not yet matured, known as reissue of loans; and
Cash financing, i.e., raising fresh cash resources.

Trading Procedure in Gilt-edged Securities Market

Transactions in the gilt-edged market are carried out in the following ways:

Through vouchers, i.e., direct sales
Through securities general ledger (SGL) accounts, and
Through bank receipts (BRs)

Direct sale of government securities is affected by Public Debt Office (PDO) by pre-specifying the loan amount and the dates when subscription for government loans would be open. In case of transactions through SGL, the transactions are recorded as book entries by RBI only in the ledger on the date of the transaction and at the value at which the transaction has taken place. Under the system each dealing bank maintains an SGL account with RBI on account of the balance of the Central Government securities. The transactions are effected by selling bankers by filling out the prescribed SGL form which is then lodged with RBI. SGLs facilitate ‘repo’ transactions. A ‘repo’ or Ready Forward (RF) refers to a sale transaction with a stipulation to buy-back the securities at a stipulated future date, at a price determined on the date of sale transaction. To avoid physical transfer of securities, the selling bank issues a bank receipt (BR) instead. In this case it is called transaction through BR. This avoids the hassle of writing the SGL forms and lodging them the RBI. This process is resorted to when the ‘repo’ transaction is for a short time. However, conduct of short operations by banks i.e., selling government securities without owning them with a views to neutralizing the transaction by buying them at a later date) through Issue of BRs is being discouraged by RBI.

Types of Government Bonds

Zero coupon bonds: These are bonds issued at discount and repaid at face value. the difference between the issue price and the redemption price represents the return to the investor. No periodic Interest payment is made. Zero Coupon bonds bear no reinvestment risk but they are prone to interest rate risk making their prices highly volatile. The buyers of zero coupon bonds make a series of periodic coupon payments to the buyer as well as paying face value at maturity. Zero Coupon Bonds on auction basis with introduced in January 1994 by Government of India.
Floating rate bonds: These are instruments whose periodic interest or dividend rates are indexed to some reference index such as Treasury bills etc. these instruments give a variable rate, a characteristic that allows both issuer and investor to share the risk inherent in changing interest rates. The volatility of interest rates have led to creation of these instruments designed to offer some protection to the players. Thus, Floating Rate Bonds enable investors to take advantage of movements in interest rates. Floating Rate Bonds were introduced by Government of India on September 29, 1995 linking it to 364 day Treasury bill rate.
Tap stock: This is a gilt edged security from an issue that has not been fully subscribed and is released into the market slowly when its market price reaches predetermined levels. Short taps are short dated stocks and long taps are long dated socks. These stocks were introduced by Government of India on July 29, 1994.
Partly paid stock: This is an innovative instrument (Government stock auctioned on November 15, 1994) for which the payment is made in installments. It is designed for institutions with regular flow of investible resources requiring regular investment outlet. The instrument has attracted good market response and is being traded actively.
Capital indexed bonds: These bonds were floated on December 29, 1997 on tap basis. These bonds are of four year maturity and carry a coupon rate of 6 per cent. The objectives of the capital indexed bonds were to provide a complete hedge against inflation for the principal amount of the Investment.
Strips: “STRIPS” stands for Separately Traded Registered Interest and Principal of Securities. Strips are created by separating the coupon from the principal and trading them independently. Thus, if a conventional bond of five year maturity has ten semi annual coupon payments and one payment of principal, ten coupon STRIPS and one Principal STRIP will be created on stripping the bond.

Prices and Yields

Three types of prices are prevalent in gilt-edged securities market:

RBI prices. These are prices for deals with RBI. These are not cash prices. RBI publishes a price list from time to time for securities dealt in by it. These prices are so aligned that the yield on these securities for the remaining maturity period is the same as on the bonds of similar maturity which are currently issued.
Prices prevailing in the secondary market at which deals take place between different operators.
Artificial or loaded prices fixed by the brokers for producing deals in securities. For helping banks to show higher book profits the dealers buy depreciated securities at an inflated price above the market price and sell the same amount of some other security to the bank again at inflated price so as to neutralize its loss on purchase. Such artificial prices distort computation of yield on securities.