WHAT IS A GOVERNMENT BOND?
A government bond is a form of security sold by the government. It is called a fixed income security because it earns a fixed amount of interest every year for the duration of the bond. The purpose of a government bond is to raise money to operate the government and to pay down debt.
Government bonds are considered to be secure. That is, it is very unlikely that the government will default. Bonds have maturity dates that may vary from one month to 30 years.
TYPES OF GOVERNMENT BONDS.
- Treasury Bills: Treasury bills, also known as T-bills, are short term government bonds. They are issued for maturity within one year. The government issues these bonds in three categories, i.e. 91 days, 182 days and 364 days. The investors do not get coupon payments. However, the difference between the face value and the discounted value is the profit for the investors.
- Fixed-Rate Bonds: Government bonds of this nature have a fixed coupon rate throughout the tenure of the bond. In other words, the interest rate remains constant for the entire investment tenure irrespective of the fluctuating market rates.
- Floating Rate Bonds: As the name suggests, the interest rate of these bonds keeps fluctuating during the investment. The interest rate changes are undertaken at intervals which are declared before the bond is issued.
- Zero Coupon Bonds: As the name suggests, Zero coupon bonds have no coupon payments. The profits from these bonds arise from the difference in the issue price and redemption value. In other words, these bonds are issued at a discount and redeemed at par. Further, these bonds are not issued through auction but created through existing securities.
- Bonds with Call or Put Option: These bonds come with an option where the issuer has the right to buy back the bond (call option), or the investor can exercise its right to sell bonds to the issuer (put option). The investor or the issuer can exercise the rights only after five years from the date of issue.
- Special Securities: The Government of India issues special securities from time to time to entities like oil marketing companies, fertilizer companies, the food corporation of India, etc. The government issues these securities as compensation to these companies instead of cash subsidies.
- Inflation Indexed Bonds: The InflationIndex bonds (IIBs) are where the principal amount and the interest payment is linked to an inflation index. The inflation index may be the Consumer Price Index (CPI) or the Wholesale Price Index (WPI). Investments in such bonds ensure real returns which remains constant. Also, it can safeguard the investor’s portfolio against inflation rates.
ADVANTAGES OF INVESTING IN GOVERNMENT BONDS
- Risk-Free: Government bonds promise assured returns and stability of funds to investors. They have always been an example of risk-free security. Thus, investors looking for a risk-free investment, government bonds are suitable for them.
- Returns : The returns from government bonds are generally as good as bank deposits. Also, there is a guarantee of principal along with fixed interest. Unlike bank deposits, these bonds are available for a longer duration.
- Liquidity : One can buy and sell government bonds like equity instruments. The liquidity in these bonds is as adequate as banks and financial institutions.
- Portfolio Diversification: Investment in government bonds makes a well-diversified portfolio for the investor. It mitigates the risk of the overall portfolio since government bonds are risk-free investments.
DISADVANTAGES OF INVESTING IN GOVERNMENT BONDS
- Low Return
- Intrest Rate Risk