History repeats itself with the second article of mine, updated with latest instructions on government securities, particularly after the first one published in 2018 on the same subject. Introduction of an electronic screen-based trading system, dematerialized holding, straight through processing, establishment of the Clearing Corporation of India Ltd. (CCIL) as the Central Counter Party (CCP) for guaranteed settlement, and changes in the legal/monetary environment as well as the vast changes thrust on the Indian economy by RBI are the new developments. RBI on April 1, 2020 published under the following web site, 32 questions and answers as well as 7 annexures for easy understanding of information under “Government Securities Market in India – A primer”, wealth of information easy understandable to any lay man though professionals use it for making money.
https://rbi.org.in/scripts/FAQView.aspx?Id=79
15 of the questions and answers in a layman’s language was incorporated in my earlier article. Hence, I do intend to deal with other 17 of them first and later give a summary for others. Yes, it is very important to understand Government Securities thoroughly with the latest thrust of RBI to enlarge the securities market and introduction of bonds for easy liquidity in the market. We are no more an emerging market – an energetic and live wire to make money in the world.
I do hope to introduce the Q&A format for easy comprehension.
What is Liquidity Adjustment Facility (LAF) and whether Re-repo in Government Securities Market is allowed?
LAF is a facility extended by RBI to the scheduled commercial banks (excluding RRBs) on a day to day basis to deposit or withdraw funds which we may call as liquidity managements also. The operations of LAF are conducted by way of repurchase agreements with RBI being the counter-party to all transactions. Obviously, the interest rate in LAF is fixed by RBI.
How do the G-Secs transactions settle?
Let us analyze the settlements both in primary as well as secondary market in seriatim.
Primary market
Successful participants are informed of their allotment as soon as the allotment process is finished and the consideration amount to be paid informed. The settlement cycle for all kinds of G-Secs is T+1 which to a common man means funds and securities are settled on next working day from the conclusion of trade. It is clear on the settlement date the total amounts will be duly debited and securities accounts duly credited with the amount of securities. Though I have tried to explain in simple terms, with the most modern modes of payments/receipts of funds, every thing is done at a click of a finger tips through computers or other communication means.
Secondary market
Quoting directly from the web site” The transactions relating to G-Secs are settled through the member’s securities / current accounts maintained with the RBI. The securities and funds are settled on a net basis i.e. Delivery versus Payment System-III. CCIL guarantees settlement of trades on the settlement date.”
My observations
It is quite simple for any SCB which regularly operates through primary and secondary markets with specialist officials who are nowadays certified and trained to do the jobs. I have seen the birth of PNB Gilts Ltd under the tutelage of Punjab National Bank which embarked the entry of experts in the routine commercial public sector bank operations in G Secs.
What is shut period?
Expectedly, shut period enables no purchase or sale of securities and time to settle the accounts. Currently, shut period is only one day.
Now it is time to learn about Clearing Corporation of India (CCIL), the pivot of operation of G-Secs.
Clearing Corporation of India (CCIL) and its role in keeping the market moving
The CCIL is the clearing agency for G-Secs. It acts as a Central Counter Party (CCP) for all transactions in G-Secs by interposing itself between two counterparties. In effect, during settlement, the CCP becomes the seller to the buyer and buyer to the seller of the actual transaction. Yes, you can call it the nerve center of G-Secs operations.
All outright trades undertaken in the OTC market and again on NDS-OM platform are cleared through CCIL, ensuring accuracy, secrecy or reliability. Enabling the monetary operations ceaselessly, it ensures participant wise net obligations both on the securities and funds leg. All gilt account holders get their receivable or payable position at the tip of their hands, totally carefree. With volumes of transactions running thousands of Crores in amounts, CCIL is doing a competent job, really a rare honor for our nation.
Please do tell me about “when issued market” and “short sale”, most commonly heard terms in the G Secs market
When, as and if issued” (commonly known as ‘When Issued’) security refers to a security that has been authorized for issuance but not yet really issued. It takes place between the time a Government Security is announced for issuance and the time it is actually issued. All ‘When Issued’ transactions are on an ‘if’ basis, to be settled if and when the actual security is issued. RBI does issue regular guidelines/ instructions on when issued subject regularly for proper follow up. Consistent instructions were issued in 2018 followed by time and again.
As a beginner, what are the mathematical concepts one is expected to know, the bare minimum for entering the Govt securities market, particularly bonds and the yields
Most commonly words used in G Securities market are the time value of money functions related to calculation of Present Value (PV), Future Value (FV), related to bond market. If you want to learn more deeply please refer question number 21 for detailed explanation. Any beginner in bonds market learns the terms, their applicability or actual verification of bond values, their yields etc.
Can we learn how the price of a bond is calculated, what is the total consideration amount of a trade or what is an accrued interest?
Being unable to explain in simple terms, please permit me to quote from RBI direct as under:
“The price of a bond is nothing but the sum of present value of all future cash flows of the bond. The interest rate used for discounting the cash flows is the Yield to Maturity (YTM). Price can be calculated using the excel function ‘Price’
Accrued interest is the interest calculated for the broken period from the last coupon day till a day prior to the settlement date of the trade. Since the seller of the security is holding the security for the period up to the day prior to the settlement date of the trade, he is entitled to receive the coupon for the period held. During settlement of the trade, the buyer of security will pay the accrued interest in addition to the agreed price and pays the ‘consideration amount”.
Let me be honest with you. Any reader of this article may easily upgrade his skills from books, advanced software or qualified G Securities experts about the price of a bond, its calculation or the meaning of accrued interest. Nowadays computers with advanced software have simplified the learning process for excellent understanding.
What is the relationship between yield and price of a bond?
If market interest rate levels rise, the price of a bond falls. Conversely, if interest rates or market yields decline, the price of the bond rises. In other words, the yield of a bond is inversely related to its price. Let me explain in normal terms. The price of a bond is Rs 100 and its market yield is 6% per annum. Applying the above norm, value of Rs 100 will go up if the yield takes a lesser price of say 5% or less.
I want to calculate the yield of a bond. How to help this request?
An investor who purchases a bond can expect to receive a return from the coupon interest payments that would be made by the buyer, any capital gain/loss at the time bond is either sold or matured or income from reinvestment of interest payments which would be interest -on- interest.
What is Duration?
Duration is explained as the pay back period of the bond to break even, i.e., the time that will be taken by the bond to repay its purchase price. Any business man would like to know this duration for recovery of the capital. One can easily refer to item no 27 for detailed calculation. I have emphasized earlier that computers with the best software do the tricks these days with regard to any mathematical calculation.
I would like to give some important guidelines for valuation of securities.
RBI vide FMRD.DIRD.7/14.03.025/2017-18 dated March 31, 2018 has notified that Financial Benchmark India Pvt. Ltd (FBIL) has been advised to assume the responsibility for administering valuation of Government securities with effect from March 31, 2018.
Similarly, RBI vide its notification DBR.BP.BC.No.002 /21.04.141/2018-19 dated July 27, 2018 decided that securities issued by each state government, i.e., State Development Loans (SDLs), shall be valued in a manner which would objectively reflect their fair value based on observed prices/yields and Financial Benchmarks India Pvt. Ltd. (FBIL) shall make available prices for valuation of SDLs based on the above principles. Obviously, any one serious about these valuations can easily refer to FBIL for authentic values without any misguidance.
Risk involved in holding G-Secs
G-Secs are generally referred to as risk free instruments as sovereigns rarely default on their payments. However, as is the case with any financial instrument, there are risks associated with holding the G-Secs. Hence, it is important to identify and understand such risks and take appropriate measures for mitigation of the same. One has never heard of Government of India failing to honor its securities. With the best economic condition in spite of worldwide epidemic condition of the world, Indian G Security market is at its strongest level.
The following are the major risks associated with holding G-Secs:
- Market risk– Market risk arises out of adverse movement of prices of the securities due to changes in interest rates. This will result in valuation losses on marking to market or realizing a loss if the securities are sold at adverse prices. Market risk is inherent in all types of investments.
- Reinvestment risk– Cash flows on a G-Sec includes a coupon every half year and repayment of principal at maturity. These cash flows need to be reinvested whenever they are paid.
- Liquidity risk- Yes, the necessity to buy and sell the G Securities on a narrow band of time is always there.
However, as a banker with nearly 4 decades of professional experience, I do not really envisage any risk associated with G Securities. But your experts would guide you.
Various web sites that throw light on G-Secs.
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- https://rbi.org.in/scripts/financialmarketswatch.aspx
- NDS-OM market watch https://www.ccilindia.com/OMHome.aspx
- Reported deals on NDS-OM: https://www.ccilindia.com/OMRPTDeals.aspx
- FBIL – fbil.org.in
Any one interested in dealing with G Securities would be interested in the list of primary dealers since huge investments are involved.
Update to the list of Primary dealers is available on the RBI website at https://www.rbi.org.in/Scripts/AboutUsDisplay.aspx?pg=PrimaryDealer.htm
Conclusion
Fully knowing that a government security is a tradable instrument issued either by Central government or State Governments acknowledged by governments as debt obligation, recent emphasis on issuing more securities by governments to increase liquidity as well as the safest way of investment by financial institutions, wealthy individuals or any one having the interest in the welfare of India but with strict sense of security and liquidity, motivated me to write this article. Yes, time has come for Indian investments to look deeply at Government securities either on short term duration or longer ones by engaging top financial professionals who are certified to handle complex transactions. Though this article or my earlier one in 2017 tried to touch various aspects of the subject, I expect the best professionals with the high-tech instruments with advanced software to handle the transactions. But if my article creates the motivation for managers at various levels to learn and insist on top management to indulge in Government Securities, I am happy with the outcome.
As a developed country in the process, my expectations are not too much about India.
Reference:
My first article in taxguru.in on 5th February 2018.
https://taxguru.in/rbi/understand-government-securities-distinguishing-features.html
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