GOVERNMENT

SECURITIES IN INDIA
&
Role In
Risk Mitigation & Treasury
 Government Security

A tradable instrument issued by the Central Government or

the State Governments
It acknowledges the Governments debt obligation.
In India, the Central Government issues both, treasury bills
and bonds or dated securities while the State Governments
issue only bonds or dated securities, which are called the
State Development Loans (SDLs)
Government securities carry practically no risk of default
and, hence, are called risk-free gilt-edged instruments.
 Types of Government
Securities

Dated Government Securities

Fixed Rate Bonds
Floating Rate Bonds
Zero Coupon Bonds
Special Securities

Treasury Bills (T-bills)

Cash Management Bills (CMBs)
 Dated Government Securities

long term securities

carry a fixed or floating coupon
(interest rate)
paid on the face value, payable at
fixed time periods (usually half-
yearly).
The tenor of dated securities can be
up to 30 years.
 Example

8.23% GS 2021 would mean:

Coupon : 8.23% paid
on face value
Name of Issuer : Government
of India
Date of Issue : May 12,
2009
Maturity : May 12,
2021
Coupon Payment Dates : Half-yearly
Minimum Amount of issue/ sale : Rs.10,000
 Special Securities

issued to entities like Oil Marketing

Companies, fertilizer Companies, the
Food Corporation of India, etc.
Special securities are as
compensation by GOI in lieu of cash
subsidies.
These securities are, however, not
eligible SLR securities but are eligible
as collateral for market repo
transactions.
Why should one invest in
Government securities?

Holding of cash in excess of the day-to-day

needs of a bank does not give any return to it.
Investment in gold has attendant problems in
regard to appraising its purity, valuation, safe
custody, etc.
Investing in Government
securities has the following
advantages:

Besides providing a return in the form of coupons

(interest), Government securities offer the maximum
safety as they carry the Sovereigns commitment for
payment of interest and repayment of principal.
They can be held in book entry, i.e.,dematerialized/
scrip less form, thus, obviating the need for
safekeeping.
Government securities are available in a wide range of
maturities from 91 days to as long as 30 years to suit
the duration of a bank's liabilities
 Government securities can be sold easily in the
secondary market to meet cash requirements.
Government securities can also be used as
collateral to borrow funds in the repo market.
The settlement system for trading in
Government securities, which is based on
Delivery versus Payment (DVP), is a very
simple, safe and efficient system of settlement.
 Yield to Maturity (YTM)

Expected rate of return on a bond if it is held

until its maturity
It is the discount rate which equates the
present value of the future cash flows from a
bond to its current market price
It is the internal rate of return on the bond.
 Yield Curve

A plot of YTM against time for various

maturities for a specific class of bonds.
Usually done for G-Secs (or Treasuries), in
which case it is described as the Treasury
benchmark (risk-free) yield curve
 How are the Government
Securities issued?

Government securities are issued through auctions

conducted by the RBI

Auctions are conducted on the electronic platform

called the NDS Auction platform

The RBI, in consultation with the Government of India,

issues an indicative half-yearly auction calendar which
contains information about the amount of borrowing,
the tenor of security and the likely period during which
auctions will be held.
How are the Government Securities issued?

A Notification and a Press Communique giving exact

particulars of the securities, viz., name, amount, type of
issue and procedure of auction are issued by the
Government of India about a week prior to the actual
date of auction.
RBI places the notification and a Press Release on its
website (www.rbi.org.in) and also issues an
advertisement in leading English and Hindi newspapers.
Information about auctions is also available with the
select branches of public and private sector banks and
the Primary Dealers.
What are the different types of
auctions used for issue of
securities?

Yield Based Auction

Price Based Auction

 Yield Based Auction

generally conducted when a new Government

security is issued.
Investors bid in yield terms up to two decimal
places
Bids which are higher than the cut-off yield
are rejected.
Successful bidders are those who have bid at
or below the cut-off yield
 Example

Maturity Date: September 8, 2018

Coupon: It is determined in the auction
(8.22% as shown in the illustration below)
Auction date: September 5, 2016
Auction settlement date: September 6, 2016
Notified Amount: Rs.1000 crore
 Example

Amount of bid (Rs. Cummulative Price* with coupon as

Bid No. Bid Yield
crore) amount (Rs.Cr) 8.22%

1 8.19% 300 300 100.19

2 8.20% 200 500 100.14

3 8.20% 250 750 100.13

4 8.21% 150 900 100.09

5 8.22% 100 1000 100

6 8.22% 100 1100 100

7 8.23% 150 1250 99.93

8 8.24% 100 1350 99.87

 Example

The issuer would get the notified amount by

accepting bids up to 5.
Since the bid number 6 also is at the same
yield, bid numbers 5 and 6 would get
allotment pro-rata so that the notified amount
is not exceeded.
In this case each would get Rs. 50 crore. Bid
numbers 7 and 8 are rejected as the yields
are higher than the cut-off yield.
 Price Based Auction

conducted when Government of India re-

issues securities issued earlier
Bidders quote in terms of price per Rs.100 of
face value of the security (e.g. Rs.101.00,
Rs.100.00, Rs.99.00, etc.)
Bids which are below the cut-off price are
rejected
 Example

Price based auction of an existing security

8.24% GS 2018
Maturity Date: April 22, 2018

Coupon: 8.24%

Auction date: September 5, 2016

Auction settlement date: September 6,2016

Notified Amount: Rs.1000 crore

 Example

Amount of bid (Rs. Implicit Cumulative

Bid no. Price of bid
Cr) yield amount

1 100.31 300 8.1912% 300

2 100.26 200 8.1987% 500

3 100.25 250 8.2002% 750

4 100.21 150 8.2062% 900

5 100.20 100 8.2077% 1000

6 100.20 100 8.2077% 1100

7 100.16 150 8.2136% 1250

8 100.15 100 8.2151% 1350

 Example

The issuer would get the notified amount by

accepting bids up to 5.
Since the bid number 6 also is at the same price, bid
numbers 5 and 6 would get allotment in proportion
so that the notified amount is not exceeded.
In the above case each would get Rs. 50 crore.
Bid numbers 7 and 8 are rejected as the price
quoted is less than the cut-off price.
 Open Market
Operations

Conducted by the Reserve Bank of India by way of

sale/ purchase of Government securities to/ from the
market with an objective to adjust the rupee liquidity
conditions in the market on a durable basis.

When the RBI feels there is excess liquidity in the

market, it resorts to sale of securities thereby sucking
out the rupee liquidity and vice versa.
 Buyback of Government
securities
process whereby the Government of India and State
Governments buy back their existing securities from the
holders.
Objectives :-

reduction of cost (by buying back high coupon securities)

reduction in the number of outstanding securities and

improving liquidity in the Government securities market
(by buying back illiquid securities)
infusion of liquidity in the system
 How does the trading in
Government securities take
place?

Over the Counter (OTC)/ Telephone Market

Buyer 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.
Continued

Negotiated Dealing System

facilitates the members to submit

electronically, bids or applications for primary
issuance of Government Securities when
auctions are conducted
the participants can trade anonymously by
placing their orders on the system or
accepting the orders already placed by other
participants
 Stock Exchanges

Facilities are also available for trading in

Government securities on stock exchanges
(NSE, BSE) which cater to the needs of retail
investors.
GOVERNMENT
SECURITIES

Role in Treasury, Risk &

Mitigation
 Role in Treasury
Helps in complying with compulsory requirement of SLR
and CRR

Government securities are available in a wide range of

maturities from 91 days to as long as 30 years to suit the
duration of a bank's liabilities, i.e. a bank can invest in
various buckets to meets its maturing assets.

Balancing and rebalancing of portfolio.

It offer the maximum safety as they carry the Sovereigns

commitment for payment of interest and repayment of
principal, thereby reducing risk of default.
 Government securities are generally referred
to as risk free instruments as sovereigns are
not expected to default on their payments.
However, there are risks associated with
holding the Government securities.
Hence, it is important
to identify and understand such risks and
take appropriate measures for mitigation of the
same.
 Types of Risks

The following are the major

risks associated with
holding Government
securities.
Market Risk

Liquidity Risk

Reinvestment Risk

Interest Rate Risk

 Market Risk

Market risk arises out of adverse movement of prices

of the securities due to changes in interest rates.
This results in booking losses on marking to market or
realizing a loss if the securities are sold at the
adverse prices.
Generally, the longer the maturity of a security, the
greater its market risk as measured by price volatility.
Longer maturities have greater volatility because as
the time to maturity increases, each change in
interest rates has a greater impact on the present
value of a security.
Continued

The size of a security coupon also affects price

volatility.
Securities with low coupons will have greater
price volatility than securities with high
coupons.
Reason: If your bond is paying 4% and rates
are in an upward swing, the difference in the
market yield and your yield will continue to
widen, which will push your bond values down.
 Liquidity Risk
Liquidity risk refers to the inability of an investor to
liquidate his holdings due to non availability of buyers
for the security, i.e., no trading activity in that particular
security.
However, in such cases, eligible investors can
participate in market repo and borrow the money
against the collateral of the securities.
Liquidity Exposure can stem from both internally and
externally.
External liquidity risks can be geographic, systemic or
instrument specific.
Internal liquidity risk relates largely to perceptions of
an institution in its various markets: local, regional,
national or international
 Interest Rate Risk
Interest Rate risk is the exposure of a banks financial
conditions to adverse movements of interest rates.
Though this is normal part of banking business,
excessive interest rate risk can pose a significant threat
to a banks earnings and capital base.
Changes in interest rates also affect the underlying
value of the banks assets, liabilities and off-balance-
sheet Interest rate risk refers to volatility in Net Interest
Income (NII) or variations in Net Interest Margin(NIM).
Therefore, an effective risk management process that
maintains interest rate risk within prudent levels is
essential to safety and soundness of the bank.
 Reinvestment Risk

This is the riskthat the proceeds from the payment

of principal and interest, which have to be
reinvested at a lower rate than the original
investment.
Cash flows on a Government security includes fixed
coupon every half year and repayment of principal
at maturity.
These cash flows need to be reinvested whenever
they are paid.

Hence there is a risk that the investor may not be able

to reinvest these proceeds at profitable rates due to
changes in interest rate scenario.
 Reinvestm
Example ent Risk

Interest
Rate

You won a lottery of Rs. 5,00,000 and youll

invest the money and live off the interest.
Suppose you have invested in 1-year
government bond at par having 9% coupon rate.
Year 1 Income=45,000 and at year end you will
get back Rs.5,00,000 to reinvest.
If rate falls to 5%, your income will reduce from
45,000 to 25,000. Had you bought 30 year govt.
bond it would have remain constant.
 Mitigation

1. Duration
2. Modified Duration
3. ALM
4. Gap Analysis
5. Other Methods
 Duration
Duration refers to the weighted average term (time from now
to payment) of a bond's cash flows or of any series of linked
cash flows.

The higher the coupon rate of a bond, the shorter the

duration (if the term of the bond is kept constant). because
when a bond pays a higher coupon rate or has a high yield,
the holder of the security receives repayment for the security
at a faster rate

Duration is useful primarily as a measure of the sensitivity of

a bond's market price to interest rate (i.e., yield) movements.

It is approximately equal to the percentage

change in price for a given change in yield.

For example.
 Ram holds a five-year bond with a par value of
$1,000 and coupon rate of 5%. For simplicity, let's
assume that the coupon is paid annually and that
interest rates are 5%. What is the Macaulay duration
of the bond?
 Continued

Another example, for small interest rate changes, the

duration is the approximate percentage by which the
value of the bond will fall for a 1% per annum increase
in market interest rate.

So a 15-year bond with a duration of 7 years would fall

approximately 7% in value if the interest rate increased
by 1% per annum.

Duration is always less than or equal to the overall life

(to maturity) of the bond.
 Modified Duration
A widely used measure of market risk in the investment
industry isModified Duration.
Duration takes into consideration all cash flows (interest and
principal payments) of a fixed-income security using their
present values.
Modified duration (MD) is a modified version of Macaulay
Duration. Since, bond price and interest rate move in opposite
directions, so there is an inverse relationship between modified
duration It refers to the change in value of the security to one
per cent change in interest rates (Yield). The formula is
 Because the modified duration formula shows how a bond's
duration changes in relation to interest rate movements, the
formula is appropriate for investors wishing to measure the
volatility of a particular bond.

Let's continue to analyze Rams bond. Currently her bond is

selling at $1,000, or par, which translatesto a yield to maturity
of 5%.

Remember that we calculated a Macaulay duration of 4.55

My example shows that if the bond's yield changed from 5% to

6%, the duration of the bond will decline to 4.33 years. Because it
calculates how duration will change when interest increases by
100 basis points, the modified duration will always be lower than
the Macaulay duration
 Assets Liability
Management
It is a dynamic process of Planning, Organizing &
Controlling of Assets & Liabilities- their volumes, mixes,
maturities, yields and costs in order to maintain liquidity
and NII.

It is aimed to stabilize short-term profits, long-term

earnings and long-term substance of the bank. The
parameters for stabilizing ALM are NII, NIM and EEQ
ALM helps to meet liquidity needs.
Arranging maturity patterns of A&L,
keeping a price tag by limiting their
exposure to interest rate risk.
Controlling Rates received and paid to A/L
to maximize spread (NII).
 Statement of Structural
Liquidity

All Assets & Liabilities to be reported as per

their maturity profile into 8 maturity Buckets:
1. 1 to 14 days
2. 15 to 28 days
3. 29 days and up to 3 months
4. Over 3 months and up to 6 months
5. Over 6 months and up to 1 year
6. Over 1 year and up to 3 years
7. Over 3 years and up to 5 years
8. Over 5 years
 Statement of Structural
Liquidity

Places all cash inflows and outflows in the maturity

ladder as per residual maturity
Maturing Liability: cash outflow
Maturing Assets : Cash Inflow
Classified in to 8 time buckets
Mismatches in the first two buckets not to exceed
20% of outflows
Shows the structure as of a particular date
Banks can fix higher tolerance level for other
maturity buckets.
 Addressing the Mismatches in
Structural Liquidity

Mismatches can be positive or negative

Positive Mismatch: M.A.>M.L. and Negative Mismatch
M.L.>M.A.
In case of +ve mismatch, excess liquidity can be deployed
in money market instruments, creating new assets &
investment swaps etc.
For ve mismatch, it can be financed from market
borrowings (Call/Term), Bills rediscounting, Repos &
deployment of foreign currency converted into rupee.

To meet the mismatch in any maturity bucket, the bank

has to look into taking deposit and invest it suitably so as
to mature in time bucket with negative mismatch.
 As per RBI guidelines the negative gap during 1day, 2-7
days, 7-14 days and 15-28 days time-buckets should not
exceed 5%, 10%, 15% and 20 %
 ALM help to mitigate
Liquidity Risk
Interest Rate Risk
Reinvestment Risk
 Measurement of Interest
Rate Risk using Gap
Analysis
Gap analysis measures mismatches between rate sensitive
liabilities and rate sensitive assets (including off-balance
sheet positions).

Statement of Interest Rate Sensitivity

Generated by grouping RSA,RSL & OFF-Balance sheet items in
to various (8) time buckets

RSA:
Money at call
Advances ( bplr linked )
Investment

RSL:
Deposits excluding CD
Borrowings
 Gap Interest rate Impact on NII
Analysis Change
Positive Increases Positive

Positive Decreases Negative

Negative Increases Negative

Negative Decreases Positive

If a positive gap (RSA>RSL) in a given time band,

an decrease in market interest rates could cause a
decline in NII.
Conversely, if a negative gap occurs (RSA<RSL) in
given time band, an increase in market interest
rates could cause a decline in NII.
 Others Methods

Rebalancing the portfolio wherein the securities are sold once

they become short term and new securities of longer tenor
are bought could be followed to manage the portfolio risk.
However, rebalancing involves transaction and other costs
and hence needs to be used judiciously
The entire investment portfolio of the banks(including SLR
securities and non-SLR securities) are classified under
three categories :
Held to Maturity (HTM): The securities acquired by the banks
with the intention to hold them up to maturity.
Held For Trading (HFT) : Intention to trade by taking
advantage of the short-term price/interest rate movements. Sell
within 90 days.
Available for Sale (AFS): The securities which do not fall
within the above two categories.
 Holding securities till maturity could be a strategy
through which one could avoid market risk.
Bank Policy & Trade Policy Document.
Liquidity Policy
Eg. Specification of alternate sources in midst's of
illiquidity (like disposal of Govt. Securities.
Investment Policy
Eg listing of acceptable investments, their composition as
% to total investment, price ranges and guidelines for
trading etc.