Government Bonds: A substitute for Bank FDs or not!!!

In India, maximum percentage of investors are risk averse. “Willing to invest, unwilling to take risk” is the proverb describing the nature of Indian investors. Naturally whenever we think of risk free investment options bank fixed deposits are given preference. But there are many other financial instruments which are safer than your bank FDs. Yes, there is a risk associated with bank FDs. Most of the investors don’t know about this so let us tell you that your money kept with commercial bank in form of bank deposits such as FDs, RDs, & SBs are insured up to an amount of 1 lakh, which means in case of any uncertain event Banks are only liable to pay you upto only 1 lakh for each account even if you had more amount in the account at the time of incident. So, to avoid this risk we can choose sovereign bonds which are issued by Government of India. When government needs funds, it usually sells bonds to public. When you invest in these bonds government pays interest & repays the principal on maturity. These are safe heaven debt instrument. Sovereign rating makes this financial instrument safest bond. These bonds are issued with coupon which is interest rate paid annually, quarterly or half yearly. Unlike commercial banks, government is liable to pay the principal along with the interest on maturity even in case of uncertain incidents. So, technically sovereign bonds are safer than bank FDs. The GOI issues these bonds from time to time for periods of 5 years, 7 years and 10 years maturity. The yield on these sovereign bonds at which they are issued depends on 10year G-sec yield (the benchmark index for every bond coupon rate). Sovereign bonds usually have a spread of 15 bps from the benchmark. Let us look at the graphs & figures of 10year G-sec yield of sovereign bonds to get a better picture:

sovbindyeild

YTDYeild

There are various types of Government bonds, let us discuss the types in the following points for having a clear conception:

  • Fixed or Floating rate bonds– Fixed rate bonds have fixed coupon rate till maturity, on contrary Floating rate bonds have fluctuating rate linked with the G-sec yield up to maturity.
  • Zero coupon bonds– These are deep discount bonds which are issued at a discount from their face value having no coupon but the at the time of maturity the face value is paid back to the investors. This difference between the issue price and face value is the gain for investors.
  • Capital Index bonds– These are inflation linked bonds whose yield increase or decrease on the basis of CPI (Consumer Price Index).
  • Callable bonds– Callable bonds are those where issuer has an option to buy back the bonds from investors after a certain period of time before maturity.
  • Puttable bonds– Puttable bonds are those where the investor has the right but not obligation to demand for early repayment of principal.

But as all financial instruments come with their own advantages & disadvantages there are few merits and demerits of sovereign bonds as well.

Advantages:

  • These are risk free securities. Government securities are the best option for investors looking for risk free return.
  • The returns are good in long term, sometimes even better than bank deposits.
  • There is good liquidity in these government bonds.
  • Ideally good for portfolio diversification.

Disadvantages:

  • The yield or the interest rate paid is very low in comparison with other investment avenues.
  • Government bonds can lose value for a particular time if inflation rises.
  • The interest earned is taxable.

How to invest?

  • We can subscribe to these bonds from our trading – demat account in electronic form.
  • Currently GOI is going to issue 7.75% taxable bond for a maturity of 7 years starting from 1 Jan 2019.

 

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