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Government securities
A Government security is a tradable instrument
issued by the Central Government, State
Governments or Semi-government (including
local authorities like city corporations andmunicipalities, autonomous institutions like port
trusts, improvement trusts, state electricity
corporations, public corporations and other govt
agencies like IDBI, IFCI, SFCs, NABARD, LDBsetc). It acknowledges the Governments debt
obligation.
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Types of government securities
Central government can issue
Treasury Bills
Government dated securities or bonds Special rupee securities for paying India's
subscription to IMF, IBRD, ADB, IDA and
so on. Non-negotiable and non-interestbearing claims
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Types of government securities
cont..Special Securities: Government of India also
issues, from time to time, special securities toentities like Oil Marketing Companies, Fertilizer
Companies, the Food Corporation of India, etc.,as compensation to these companies in lieu ofcash subsidies.
These are
usually long dated securities, , not eligible asSLR securities but are eligible as collateral formarket repo transactions.
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Types of government securities
cont.. STRIPS (Separate Trading of Registered
Interest and Principal of Securities) : The
instruments wherein each cash flow of the fixed
coupon security is converted into a separatetradable Zero Coupon Bond and is traded. For
example, when Rs.100 of the 8.24% GS2018 is
stripped, each cash flow of coupon (Rs.4.12
each half year) will become coupon STRIP andthe principal payment (Rs.100 at maturity) will
become a principal STRIP.
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Types of government securities
cont.. State governments can issue only bonds
or dated securities, which are called the
State Development Loans (SDLs).
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Dated Government Securities
Dated Government securities are long
term securities and carry a fixed or
floating coupon (interest rate) which ispaid on the face value, payable at fixed
time periods (usually half-yearly). The
tenor of dated securities can be up to 30
years.
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Coupon : 7.49% paid on face value
Name of Issuer : Government of India
Date of Issue : April 16, 2007
Maturity : April 16, 2017
Coupon Payment Dates : Half-yearly (October16 andApril 16) every year
Minimum Amount of issue/
sale: Rs.10,000
Nomenclature of a dated fixed coupon Government security containsfollowing features - coupon, name of the issuer, maturity and face value.
For example, 7.49% GS 2017 would mean
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6.05% GS 2019 FEB,
6.05% GS 2019 JUNE,
Nomenclature of G-Secs
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Payment days for coupon and
redemption proceeds If the coupon payment date falls on a
Sunday or a holiday, the coupon payment
is made on the next working day.
if the maturity date falls on a Sunday or a
holiday, the redemption proceeds are paid
on the previous working day.
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Types of dated G-secs
Fixed Rate Bonds Bonds on which the
coupon rate is fixed for the entire life of the
bond. Most government bonds are issued
as fixed rate bonds.
For example: 8.24% GS2018 was issued on
April 22, 2008 for a tenor of 10 years
maturing on April 22, 2018.
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Types of dated G-secs cont..
Floating Rate Bonds Bonds on whichcoupon is re-set at pre-announcedintervals (say, every six months or one
year) by adding a spread over a baserate*.
* Usually base rate is the weighted averageof cut-off yield of the last three 364-dayTreasury Bill preceding the date of issue ofthe g-sec
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Types of dated G-secs cont..
Zero Coupon Bonds Zero coupon bondsare bonds with no coupon payments butare issued at deep discount and redeemed
at face value. Inflation Indexed Bonds Bonds on which
amount of principal is linked to an
accepted index of inflation (say, WPI) witha view to protecting the holder frominflation.
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Types of dated G-secs cont..
Bonds with Call (buy-back) and Put (sell)
Options at par value.
T
he option on the bond can usually beexercised after completion of five years
from the date of issuance on any coupon
date falling/due.
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Forms of government securities
Stock certificates
Promissory notes
Dematerialized forms by openingSecurities General Ledger (SGL) account
with RBI
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Government securities as
promissory notes
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Mode of issuing G-secs
Issued by Public Debt Office (PDO) of the
Reserve Bank. It acts as the registry / depository
of Government securities and deals with the
issue, interest payment and repayment ofprincipal at maturity.
Issued by inviting applications from the public
unlike auctioning ofT-Bills
No prospectus is issued rather app are invited
by giving press communiqu by RBI
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Mode of issuing G-secs cont..
The budgeted amount of issue in a givenyear is raised in tranches so as to avoidflooding of market with these securities
that in turn may lead to crowing out ofprivate sector.
In case of SDLs, oversubscription of one
state govt can be transferred to other govtwhere loan is still open for subscription atthe option of subscriber.
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Mode of issuing G-secs cont..
On tap stocks: No single date for issue
and redemption as the size of the issue is
huge and continuous. RBI purchases and
gradually sells. Similarly, gradually buys
and redeem the securities until a small
portion of the securities remain
outstanding. Hence, process of issue andredemption is continuous.
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Participants of G-sec market
Central, state and semi government authoritieswhere holdings represents inter govt transfer offunds.
Banking sector comprising of RBI, SBI, other commercial banks, RRBs, Co-operative banks,NABARD
Insurance companies
Primary dealers
Provident funds and Pension funds FIIs with quantitative limits
Companies to manage their portfolio risk
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Issuing process of G-secs
Earlier the interest rates were
administered but now these are fixed by
inviting bids from the participant through
auctions.
An auction may either be yield based or
price based.
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Issuing process of G-secs cont..
Yield Based Auction
A yield based auction is generally conducted
when a new Government security is issued.
Investors submit bids for yield up to two decimal
places (for example, 8.19 per cent, 8.20 per
cent, etc.).
Bids are arranged in ascending order and the cut-off yield is arrived at the yield corresponding to
the notified amount of the auction.
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Issuing process of G-secs cont..
The cut-off yield is taken as the coupon rate
for the security.
Successful bidders are those who have bidat or below the cut-off yield.
Bids which are higher than the cut-off yield
are rejected.
For instance, notified amount was Rs. 1000
cr.
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Details of bids received in the increasing order of bid yields
Bid No. Bid YieldAmount of bid (Rs.
crore)
Cummulative amount
(Rs.Cr)
1 8.19% 300 300 Accepted
2 8.20% 200 500 Accepted
3 8.20% 250 750 Accepted
4 8.21% 150 900 Accepted
5 8.22% 100 1000 Acc+prop
6 8.22% 100 1100 Acc+prop
7 8.23% 150 1250 Rejected
8 8.24% 100 1350 Rejected
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 the above case each would get Rs. 50
crore. Bid numbers 7 and 8 are rejected as the yields are higher than the cut-off yield.
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Issuing process of G-secs cont..
Successful bidders are those who have bid
at or above the cut-off price.
Bids which are below the cut-off price arerejected. An illustrative example of price
based auction is given below:
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Details of bids received in the decreasing order of bid price
Bid no. Price of bidAmount of bid
(Rs. Cr)
Cumulative
amount
1 100.31 300 300 Accepted
2 100.26 200 500 Accepted
3 100.25 250 750 Accepted
4 100.21 150900
Accepted5 100.20 100 1000 Acc+prop
6 100.20 100 1100 Acc+prop
7 100.16 150 1250 Rejected
8 100.15 100 1350 Rejected
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.
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Issuing process of G-secs cont..
An investor may bid in an auction under either ofthe following categories:
Competitive Bidding: In a competitive bidding, an
investor bids at a specific price / yield and isallotted securities if the price / yield quoted iswithin the cut-off price / yield.
Competitive bids are made by well informed
investors such as banks, financial institutions,primary dealers, mutual funds, and insurancecompanies.
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Issuing process of G-secs cont..
Non-Competitive Bidding: With a view toencourage the participation of retail investors, anopportunity is given to them participate in theauction process, through the scheme of non-
competitive bidding (introduced in January2002).
Non-competitive bidding is open to individuals,HUFs, RRBs, co-operative banks, firms,companies, corporate bodies, institutions etc.
Under the scheme, eligible investors apply for acertain amount of securities in an auction withoutmentioning a specific price / yield.
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Issuing process of G-secs cont..
Such bidders are allotted securities at the
weighted average price / yield of the
auction.
In every auction of dated securities, a
maximum of 5 per cent of the notified
amount is reserved for such non-
competitive bids.
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Trading of G-secs
Till 2002, OTC market where trading of theGovernment securities was done telephonicallybetween buyer and seller.
Buyers and sellers have to physically submitttheir transfer forms for transfer of theGovernment securities and cheques forsettlement of the funds to the Reserve Bank ofIndia.
Manual operations being inefficient and oftenresulted in delays.
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Trading of G-secs cont..
Hence, Negotiated Dealing System (NDS)
was introduced in February, 2002 to
automate the process of trading and
settlement.
The Negotiated Dealing System (NDS) has
two modules one for the primary market
and the other for the secondary market.
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Trading of G-secs cont..
NDS Primary Market Module
This platform allows participants to
electronically submit their bids in theprimary auctions and receive allotment
reports.
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Trading of G-secs cont..
Main features of the primary auction platform are:
Creation of issues - The Reserve Bank creates asecurity issue giving the details of the security, the totalamount (notified amount) and bidding date and timings,
etc. Submission of bids Member participants can click on
the issue number and electronically submit bids byspecifying the amount and price/ yield at which they arewilling to buy the securities.
Processing of bids The Reserve Bank processes thebids and arrives at the cut-off price/yield depending onthe format of the auction.
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Trading of G-secs cont..
Allotment advice Once the cut-off price/ yield isdecided, the Reserve Bank accepts all the bidsabove/below and up to this cut-off price/yield. Thesystem automatically generates participant-wise reports
of successful bids and electronically sends them to theparticipants.
Settlement The system generates a settlement reportgiving details of the amounts that each member has topay and the quantity of securities to be issued to each
participant. Based on this report, funds account of eachmember with the Reserve Bank is debited and securitiesaccount of each member with the Reserve Bank iscredited.
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Trading of G-secs cont..
NDS Secondary Market Module
Secondary market trading in Government
securities happen over-the-counter (OTC) over
phone. Players are required to report secondary
market trades on the NDS. Once they complete
the reporting process and the NDS system
accepts trades, the data automatically flows to
the Clearing Corporation of India Ltd. (CCIL) for
clearing and settlement. This avoids paper
based settlement process.
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Trading of G-secs cont..
NDS OM System: Introduced in August, 2005.
The NDS-OM is an electronic, screen based,anonymous, order driven trading system fordealing in Government securities. The ReserveBank owns NDS-OM and CCIL maintains it.
Members can place bids (buy orders) and offers(sell orders) directly on the NDS-OM screen.
Being order driven, the system matches all bids
and offers on price/time priority and ensures thetrading of the security without actually disclosingthe identity of the buyer and seller.
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Trading of G-secs cont..
Clearing and settlement of the transactionsaffected via CCIL
Thus, the NDS-OM facilitates straight-
through-processing (STP), that is, all thetrades on the system are automaticallysent to the CCIL.
NDS-OM system captures over 80 per centof the trading volume in Governmentsecurities.
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How do the Government
securities transactions settle?In Primary Market
Once the allotment process in the primary auction isfinalized, the successful participants are advised of theconsideration amounts that they need to pay to the
Government on settlement day. The settlement cycle for dated security auction is T+1,
whereas for that ofTreasury bill auction is T+2.
On the settlement date, the fund accounts of theparticipants are debited by their respective considerationamounts and their securities accounts (SGL accounts)are credited with the amount of securities that they wereallotted.
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Settlement cycle of G-secs
In Secondary Market
All outright secondary market transactions
in Government Securities are settled onT+1 basis. However, in case of repo
transactions in Government securities, the
market participants will have the choice of
settling the first leg on eitherT+0 basis orT+1 basis as per their requirement.
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Redemption of government
securities
Redemption by the concerned
governments directly in primary market
Redemption through RBI in secondarymarket
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Redemption of government
securities cont..Redemption by the concerned governments
directly in primary market
Redemption by conversion: Refinancing of existing securities near maturity by converting
these into new securities. Redemption by advance conversion: Refunding
of existing securities before maturity by reissuingsame securities.
Objective of conversion and reissue is to lengthenthe maturity structure of government debt and toreduce the volume of cash repayment of loans
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Redemption of government
securities cont..
Redemption by Cash financing: It is the
process of redeeming existing securities
from the proceeds of newly issued
government securities
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Redemption of government
securities cont..
Redemption through RBI in secondary market
Grooming: The process whereby RBI gradually
acquires the securities (nearing maturity) from
the secondary market and redeem theseregularly just to avoid one time pressure on
government exchequer.
Switching: It is the process of converting the
govt. security nearing maturity into a new
security. Or converting by interchanging the
securities of one participant (generally a bank) to
other.
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Role of RBI in G-sec market
Most active participant in the government
securities market.
Initiates the issuing process of g-secs and also
underwrites the issue to gradually sell thesecurities in the open market to avoid crowding
outprivate sector participants
Settlement of the transactions through CCIL by
facilitating the net transfer of funds and
securities between buyers and sellers.
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Role of RBI in G-sec market cont..
Helps in the redemption of the securities
by switching and grooming activities.
Mainly switch operations.
Acts as a mediator between purchaser
and seller (which is generally a bank) in
triangular switch program.
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Role of G-secs in liquidity
management Working of two major techniques of monetary control of
RBI namely OMO and SLR are conducted throughgovernment securities to stabilize the money supply inthe economy.
Entity wise SLR Requirement: Rural Co-operative Banks = 25% of their Demand andTime Liabilities
Regional Rural Banks (RRBs) = 25% of their Demandand Time Liabilities
Scheduled UCBs have to hold 25 per cent of their SLRrequirement in Government and other approvedsecurities.
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Role of G-secs in liquidity
management cont..
Non-scheduled UCBs: with Demand and TimeLiabilities (DTL) more than Rs. 25 crore have tohold 15 per cent of their SLR requirement inGovernment and other approved securities.
Non-scheduled UCBs with DTL less than Rs. 25crore have to hold 10 per cent of their SLRrequirements in Government and otherapproved securities.
Provident funds, superannuation funds andgratuity funds = 55% of the investible funds
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Role of G-secs in liquidity
management cont.. Liquidity Adjustment facility (LAF): LAF is a facility
extended by the Reserve Bank of India to the scheduledcommercial banks (excluding RRBs) and primary dealersto avail of liquidity in case of requirement or park excess
funds with the RBI in case of excess liquidity on anovernight basis against the collateral of Governmentsecurities including State Government securities.
The operations of LAF are conducted by way of repurchase agreements with RBI being the counter-party
to all the transactions. The interest rate in LAF is fixed by the RBI from time to
time.
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Role of G-secs in liquidity
management cont..
RBI can also issue notes against the
backing of government bonds apart from
gold and foreign exchange. Hence, these
are the ultimate sources of liquidity.
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Trends in secondary G-sec market
Central govt securitiesYear Total
(in crores)
Outright
(in %)
Repos
(in %)
State
g-sec
2000-01 698146 73 27 29702001-02 1474365 77 23 6131
2002-03 1783187 72 28 9259
2003-04 2436598 63 37 25826
2004-05 2145029 41 59 35233
2005-06 2035669 32 68 67209
2006-07 2788903 23 77 63225
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Reasons for lesser developed
secondary market for g-secs Institutional investors like PFs, pension funds,
LIC and other statutory financial institutionsholds these securities till maturity and arereluctant to trade these in secondary markets.
Thus, there is lesser availability of floating stockin market for trading.
Dealing is only confined to Mumbai market thatconstitute more than 90% of the transactions.Lack of active nationwide market.
Central bank preference of refunding rather thancash redemption
Lack of varieties of instruments in the market.
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