K.E.S. SHROFF COLLEGE Page 1
TITLE PAGE NO.
1 GGOOVVEERRNNMMEENNTT SSEECCUURRIITTIIEESS 02
2 EEVVOOLLUUTTIIOONN OOFF GGOOVVEERRNNMMEENNTT SSEECCUURRIITTIIEESS MMAARRKKEETT 05
3 TTYYPPEESS OOFF GGOOVVEERRNNMMEENNTT SSEECCUURRIITTIIEESS 09
4 TTRREEAASSUURRYY BBIILLLLSS,, PPAARRTTIICCIIPPAANNTTSS AANNDD AAUUCCTTIIOONN 12
5 PARTICIPANTS IN THE GOVERNMENT SECURITIES
6 MMAANNNNEERR OOFF IISSSSUUEE OOFF GGOOVVEERRNNMMEENNTT SSEECCUURRIITTIIEESS 18
7 SSTTAATTUUTTOORRYY PPRROOVVIISSIIOONNSS FFOORR RREEGGUULLAATTIIOONN OOFF
GGOOVVEERRNNMMEENNTT SSEECCUURRIITTIIEESS MMAARRKKEETT
8 GGOOVVEERRNNMMEENNTT SSEECCUURRIITTIIEESS-- MMAARRKKEETT SSTTRRUUCCTTUURREE 24
9 RROOLLEE OOFF MMAARRKKEETT IINN GGOOVVEERRNNMMEENNTT FFIINNAANNCCEE 30
10 IIMMPPLLIICCAATTIIOONNSS FFOORR MMOONNEETTAARRYY PPOOLLIICCYY 34
11 RREECCEENNTT DDEEVVEELLOOPPMMEENNTTSS 36
12 RREEAADDYY FFOORRWWAARRDD CCOONNTTRRAACCTTSS ((RREEPPOOSS)) 37
13 DO'S AND DON‟TS FOR CO-OPERATIVE BANKS
DEALING IN GOVERNMENT SECURITIES
14 MONEY MARKET AND ROLE OF FIMMDA 40
15 RISKS INVOLVED IN HOLDING GOVERNMENT
SECURITIES AND TECHNIQUES FOR MITIGATING SUCH
16 IMPORTANT INFORMATION FOR INVESTOR
17 CONCLUSION 51
18 BIBLIOGRAPHY 52
K.E.S. SHROFF COLLEGE Page 2
The marketable debt issued by the Government and Semi-Government bodies which
represents a claim on the Government is called Government Securities. It is also called as
gilt-edged security. Government Securities are issued for the purpose of refunding the
maturing securities for advance refunding of securities which have not yet matured, and
raising fresh cash resources. Treasury Bills and Bonds are the examples of Government
Securities. One of the important features of the Government Securities is that they are
considered to be totally secured financial instruments. They ensure safety of both capital and
Central Government Securities are the safest amongst all securities. Thus Government
Securities are unique and important financial instruments in the financial market of any
country. These securities are normally issued in the denomination of Rs.100 or Rs.1000. the
face value, which was Rs.100 till the middle of 1980, was raised to Rs.1000 in the recent
years. These instruments are liquid and safe and hence the rate of interest on these
instruments is relatively lower.
There are three forms of Central and State Government Securities. Stock certificate,
Promissory note and bearer bond. Bearer bonds and stock certificates are not very popular in
India Government Securities currently are in the form of Promissory notes.
Government securities are issued by Central Government, State Government, Semi-
Government authorities like Municipal corporations, Port Trusts, State Electricity Boards,
Public Sector Enterprises and other Government agencies like IFCI, ICICI, IDBI,
NABARD,SIDCS and Housing Boards. These agencies supply government securities and the
demand essentially comes from banks, financial institutions and other investors. RBI plays an
active role in the purchase and sale of these securities as a part of its monetary management
exercise. There is no underwriting or guaranteeing required in the sale of Government
Securities, as Reserve Bank of India is Policy-bound to buy a substantial portion of the loan
unsubscribe by the public. Dealings in Government Securities are made through the
mechanism provided by the Reserve Bank of India. The Brokers and Dealers are approved by
the RBI who is eligible to deal in these securities.
One of the important features of the Government Securities is that they offer wide
ranging tax incentives to the investors. Therefore, these securities are popular in the market.
Investors in these securities get tax rebate under the Income Tax Act. The Central
Government securities have high profile of liquidity. However, state government and local
government securities have limited liquidity.
The government securities market in India has two segments, namely, primary market
and secondary market. The issue of securities by Central and State Government constitute the
primary market. The secondary market comprises the exchange of these securities by the
K.E.S. SHROFF COLLEGE Page 3
banks, financial institutions, insurance companies, provident funds trusts, primary dealers,
individuals and Reserve Bank of India. The Public Debt
Office (PDO) of the RBI undertakes to issue government securities. A notification for the
issue of securities is made a few days before the public subscription is open. The opening of
the subscription depends on the response of the market and varies between two to three days.
The issue is made in a number of branches in order to avoid flooding of securities in the
market. It facilitates smooth subscription to securities and helps to avoid sudden liquidity
problems in the market. The offices of RBI and SBI receive applications for the securities.
Government reserves the right to retain over-subscription up to a pre-specified percentage
which is normally 10 percent in excess of the notified amount of issue.
GOVERNMENT SECURITIES MARKET
A market where the Government Securities are bought and sold is called Government
Securities market. The securities are bonds, Treasury bills, Special rupee securities in
payment of India subscriptions to IMF, IBRD, ADB, IDA etc. The special rupee securities are
treated as a part of internal floating debt of the Government. These securities are issued by
the Central Government, State Governments and Semi-Government Authorities, which
include local Government authorities like City corporations and Municipalities, Port trusts,
State electricity boards Public sector corporations and other agencies like IDBI, IFCI, SFCs,
SIDCs, NABARD and Housing Boards. These agencies are suppliers of Government
Securities and banks, financial institutions and investors demand these securities in the
Government Securities offer a safe avenue of investment through guaranteed payment
of interest and repayment of Principal by the government. They offer relatively a lower fixed
rate of interest compared to interest on other securities. These Securities are issued in the
denominations of Rs. 100 or Rs.1000. They have a fixed maturity period. Interest is paid half-
Services loans as these are the liabilities of Government of India and the State
Governments. These securities are safe and risk free. These securities are also eligible as SLR
investments. As the date of maturity is specified in the securities they are also called as „dated
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RBI plays a special role in the purchase and sale of these Securities as part of its
monetary management exercise. There is no underwriting or guaranteeing required in Sale of
Government Securities. Dealing in securities take place through the mechanism provided by
the RBI. The brokers and dealers are approved by the RBI. A striking feature of these
Securities is that they offer wide ranging tax incentives to the investors. Therefore, these
securities are more popular. Under the Income Tax Act, rebates are allowed for the
investment in these securities. Each sale and purchase has to be negotiated separately; the
gild-edged market is an over-the-counter market. The Government Securities market has two
segments namely Primary market and Secondary market. The issuers are Central and State
Governments in the Primary market. The Secondary market comprises banks, Financial
Institutions, Insurance Companies, Provident funds, Trusts, Individuals, Primary dealers and
The Securities of Central and State Government are issued in the form of Stock
Certificate, Promissory notes and Bearer bonds. These Securities are mainly traded at
Bombay Stock Exchange. In terms of Size, the primary market for Governments Securities is
much bigger than the Industrial Securities Market. A notification for the issue of securities is
made a few days before the Public subscription is open. The opening of the subscription
depends on the response of the market and varies between two to three days. The issue is
made in number of branches in a year. The offices of RBI and SBI receive the applications
for the Securities. The Government, reserves the right to retain over subscription up to a pre-
specified percentage which is generally 10 percent, of the notified amount. The mechanism of
trading in Government Securities takes place through the Direct Sale, Securities General
Ledger accounts and Bank Receipts method.
K.E.S. SHROFF COLLEGE Page 5
EEVVOOLLUUTTIIOONN OOFF GGOOVVEERRNNMMEENNTT SSEECCUURRIITTIIEESS MMAARRKKEETT
The genesis of the Government Securities market arises from the requirement of the
Government to fund its deficit, which is primarily met out of borrowings. Thus, the level of
deficit determines the amount of market borrowings by the Government. In almost all the
developed countries, Government securities market is much wider and deeper than equity
market. India, however, till recently was an exception to this trend and equity market still
commanded a major share, as the Indian debt market was in its nascent stage.
Prior to liberalization of 1990s, the Government securities market was
underdeveloped partly because of inefficient market practices and partly because of limited
institutional infrastructure. Further, in order to keep the cost of Government borrowings low,
the coupon rates offered on Government securities remained negative in real terms (i.e. after
factoring in inflation) for several years till about mid-eighties. The Reserve Bank of India
also had little control over some of the essential facets of debt management, like volume and
maturity profile of debt and the interest rate structure. This, coupled with automatic
monetization of budget deficit without any limits, prevented the development of a deep and
vibrant Government securities market. A retail market for Government securities simply did
not exist. With a captive investor base through Statutory Liquidity Ratio (SLR) prescription
and interest below the market rate, secondary market for Government bonds remained
Against the above backdrop and in the context of the overall economic reforms,
development of the Government securities markets was initiated in the 1990s through
carefully and cautiously sequenced measures within a clear cut agenda for primary and
secondary market design.
In the post reforms era, considering the significance of a vibrant Government
securities market for activating internal debt management policy, a number of measures were
One major step in the reforms process was the elimination of the automatic
monetization of the Central‟s fiscal deficit by gradually phasing out ad hoc treasury bills, in
1997. A system of Ways and Means Advances (WMA) to the Central Government, subject to
mutually agreed limits at market-related rates, was put in place instead, to meet mismatches
in the cash-flows. Such phasing was necessary to permit the development of the money
markets and for a credible benchmark rate to emerge.
The RBI reserves the right to trigger floatation of fresh Government loans as and
when the actual utilization crosses 75% of the limit, WMA does not acquire the cumulative
character of ad hocs. This enables the RBI to accommodate the Government as its discretion
and helps impose market discipline.
K.E.S. SHROFF COLLEGE Page 6
Features of Government Securities
I. Governments of India Securities are sovereign debt obligations of Government of
II. Government Securities, thus, is a constituent of national debt along with State
Government Securities, Treasury bills and Government guaranteed bonds.
III. The tenors of Government securities range from two to thirty years.
IV. Coupons offered on Government Securities are either pre-determined by RBI or
arrived through competitive bidding or auction process.
V. Issues have varied from fixed semi-annual coupons and bullet redemption on
maturity, to zero coupon bonds, floating rate bonds and also securities which are
partly paid up at the time of the issue.
VI. Coupons are fixed and paid out semi-annually to the holder of the security (except
VII. Nomenclature: The coupon rate and year of maturity identifies the government
security. Example: 12.25% GOI 2008 indicates the following: 12.25% is the coupon
rate, GOI denotes Government of India, which is the borrower, and 2008 is the year of
VIII. Eligibility: All entities registered in India like banks, financial institutions, Primary
Dealers, firms, companies, corporate bodies, partnership firms, institutions, mutual
funds, Foreign Institutional Investors, State Governments, Provident Funds, trusts,
research organizations, and even individuals are eligible to purchase Government
IX. Availability: Government securities are highly liquid instruments available both in
the primary and secondary market. They can be purchased from Primary Dealers.
X. Forms of Issuance of Government Securities: Banks, Primary Dealers and
Financial Institutions have been allowed to hold these securities with the Public Debt
Office of Reserve Bank of India in dematerialized form in accounts known as
Subsidiary General Ledger (SGL) Accounts. Entities having a Gilt Account with
Banks or Primary Dealers can hold these securities with them in dematerialized form.
XI. Minimum Amount: In terms of RBI regulations, government dated securities can be
purchased for a minimum amount of Rs. 10,000/-only. Treasury bills can be
purchased for a minimum amount of Rs 25000/- only and in multiples thereof. State
Government Securities can be purchased for a minimum amount of Rs 1,000/- only.
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XII. Repayment: Government securities are repaid at par on the expiry of their tenor. The
different repayment methods are as follows:
1) For SGL account holders, the maturity proceeds would be credited to their
current accounts with the Reserve Bank of India.
2) For Gilt Account Holders, the Bank/Primary Dealers would receive the
maturity proceeds and they would pay the Gilt Account Holders.
3) For entities having a demat account with NSDL, the maturity proceeds would
be collected by their DP's and they in turn would pay the demat Account
XIII. Day Count: For government dated securities and state government securities the day
count is taken as 360 days for a year and 30 days for every completed month.
However for Treasury bills it is 365 days for a year.
K.E.S. SHROFF COLLEGE Page 8
A client purchases 7.40% GOI 2012 for face value of Rs. 10 lacs.@ Rs.101.80, i.e. the
client pays Rs.101.80 for every unit of government security having a face value of Rs. 100/-
The settlement is due on October 3, 2002. What is the amount to be paid by the client?
The security is 7.40% GOI 2012 for which the interest payment dates are 3rd May, and 3rd
November every year.
The last interest payment date for the current year is 3rd
May 2002. The calculation would be
made as follows:
Face value of Rs. 10 lacs. @ Rs.101.80%.
Therefore the principal amount payable is Rs.10 lacs X 101.80% =10,18,000
Last interest payment date was May 3, 2002 and settlement date is October 3, 2002.
Therefore the interest has to be paid for 150 days (including 3rd
May, and excluding October
(28 days of May, including 3rd
May, up to 30th
May + 30 days of June, July, August and
September + 2 days of October). Since the settlement is on October 3, 2002, that date is
Interest payable = 10 lacs X 7.40% X 150 = Rs. 30833.33.
360 X 100
Total amount payable by client =10, 18,000+30833.33=Rs. 10, 48,833.33
K.E.S. SHROFF COLLEGE Page 9
TTYYPPEESS OOFF GGOOVVEERRNNMMEENNTT SSEECCUURRIITTIIEESS
Government of India (GOI) Securities is sovereign debt obligations/instruments. They
are issued by Reserve Bank of India (RBI) on behalf of the Government to finance deficit and
public sector development programs.
1) Government of India Securities issued by Government of India.
2) State Government Securities issued by the state Governments.
3) Agency Bonds issued by Government agencies or public sector undertakings
wherein the principal and interest are guaranteed by the Central Government or
one of the state Governments.
Government Securities are further classified in the following types:
1) Dated Securities: are generally fixed maturity and fixed coupon securities usually
carrying semi-annual coupon. These are called dated securities because these are
identified by their date of maturity and the coupon, e.g., 11.03% GOI 2012 is a Central
Government security maturing in 2012, which carries a coupon of 11.03% payable half
The key features of these securities are:
a. They are issued at face value.
b. Coupon or interest rate is fixed at the time of issuance, and remains constant till
redemption of the security.
c. The tenor of the security is also fixed.
d. Interest /Coupon payment is made on a half yearly basis on its face value.
e. The security is redeemed at par (face value) on its maturity date.
2) Zero Coupon bonds: are bonds issued at discount to face value and redeemed at par.
These were issued first on January 19, 1994 and were followed by two subsequent issues
in 1994-95 and 1995-96 respectively. The key features of these securities are:
a. They are issued at a discount to the face value.
b. The tenor of the security is fixed.
c. The securities do not carry any coupon or interest rate. The difference between the
issue price (discounted price) and face value is the return on this security.
d. The security is redeemed at par (face value) on its maturity date.
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3) Partly Paid Stock: is stock where payment of principal amount is made in installments
over a given time frame. It meets the needs of investors with regular flow of funds and the
need of Government when it does not need funds immediately. The first issue of such
stock of eight year maturity was made on November 15, 1994 for Rs. 2000 crore. Such
stocks have been issued a few more times thereafter. The key features of these securities
a. They are issued at face value, but this amount is paid in installments over a
b. Coupon or interest rate is fixed at the time of issuance, and remains constant till
redemption of the security.
c. The tenor of the security is also fixed.
d. Interest /Coupon payment is made on a half yearly basis on its face value.
e. The security is redeemed at par (face value) on its maturity date.
4) Floating Rate Bonds: are bonds with variable interest rate with a fixed percentage over
a benchmark rate. There may be a cap and a floor rate attached thereby fixing a maximum
and minimum interest rate payable on it. Floating rate bonds of four year maturity were
first issued on September 29, 1995, followed by another issue on December 5, 1995.
Recently RBI issued a floating rate bond, the coupon of which is benchmarked
against average yield on 364 Days Treasury Bills for last six months. The coupon is
reset every six months
The key features of these securities are:
a. They are issued at face value.
b. Coupon or interest rate is fixed as a percentage over a predefined benchmark rate
at the time of issuance. The benchmark rate may be Treasury bill rate, bank rate
c. Though the benchmark does not change, the rate of interest may vary according to
the change in the benchmark rate till redemption of the security. The tenor of the
security is also fixed.
d. Interest /Coupon payment is made on a half yearly basis on its face value.
e. The security is redeemed at par (face value) on its maturity date.
5) Bonds with Call/Put Option: First time in the history of Government Securities market
RBI issued a bond with call and put option this year. This bond is due for redemption in
2012 and carries a coupon of 6.72%. However the bond has call and put option after five
years i.e. in year 2007. In other words it means that holder of bond can sell back (put
option) bond to Government in 2007 or Government can buy back (call option) bond from
holder in 2007. This bond has been priced in line with 5 year bonds.
K.E.S. SHROFF COLLEGE Page 11
6) Capital indexed Bonds: are bonds where interest rate is a fixed percentage over the
wholesale price index. These provide investors with an effective hedge against inflation.
These bonds were floated on December 29, 1997 on tap basis. They were of five year
maturity with a coupon rate of 6 per cent over the wholesale price index. The principal
redemption is linked to the Wholesale Price Index.
The key features of these securities are:
a. They are issued at face value.
b. Coupon or interest rate is fixed as a percentage over the wholesale price index at
the time of issuance. Therefore the actual amount of interest paid varies according
to the change in the Wholesale Price Index.
c. The tenor of the security is fixed.
d. Interest /Coupon payment is made on a half yearly basis on its face value.
e. The principal redemption is linked to the Wholesale Price Index.
K.E.S. SHROFF COLLEGE Page 12
TTRREEAASSUURRYY BBIILLLLSS,, PPAARRTTIICCIIPPAANNTTSS AANNDD AAUUCCTTIIOONN
A Treasury bill is a particular kind of finance bill or a promissory note put out by the
Government of the country. These are two types of bills i.e. 91 days Treasury bill and the 182
day Treasury bill. These treasury bills are highly liquid. There is no risk of default in case of
Treasury bills. These bills are readily available and have assured yield.
The participants in the Treasury bill market are Reserve Bank of India, State Bank of
India, Commercial Banks, State Governments and other approved bodies. Discount and
Finance House of India is the market maker in the Treasury bill market. The other
participants in the Treasury bill market are the Securities Trading Corporation of India, LIC,
UTI, GIC, NABARD, IDBI, IFCI and ICICI. Foreign Financial Institutions, Corporate
entities are also participating in the Treasury bill market.RBI and commercial banks are the
most popular players in the Treasury bill market.
Auctioning is a method of trading whereby merchants bid against one another and
where the securities are sold to the highest bidder. This system was introduced in 1992, for
the sale of dated Government Securities. A number of instruments of wide ranging period i.e.
14 day, 91day and 364day
Treasury bills and dated Securities of Government of India are sold. Bidders have to
furnish written ad sealed quotations of auction such as Multiple Price Auction and Uniform
Price Auction. Under the Multiple Price Auction, mechanism, every bidder gets allocation
according to his bid and the issuer collects a premium from all bidders by quoting a rate
lower than the cut-off yield. Under the uniform price mechanism competitive bids are
accepted on the basis of the minimum discounted price known as the cut-off price. The price
of the bill is determined at the auction. This minimum price is independent of the bid-prices
tendered below or at the cut-off price.
K.E.S. SHROFF COLLEGE Page 13
Different types of auctions used for issue of securities
Prior to introduction of auctions as the method of issuance, the interest rates were
administratively fixed by the Government. With the introduction of auctions, the rate of
interest (coupon rate) gets fixed through a market based price discovery process.
An auction may either be yield based or price based.
i. Yield Based Auction: A yield based auction is generally conducted when a
new Government security is issued. Investors bid in yield terms up to two decimal
places (for example, 7.85 per cent, 7.87 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. The cut-off yield is taken as the coupon rate for the security.
Successful bidders are those who have bid at or below the cut-off yield. Bids which
are higher than the cut-off yield are rejected. An illustrative example of the yield
based auction is given below:
Yield based auction of a new security
• Maturity Date: September 8, 2018
• Coupon: It is determined in the auction (8.22% as shown in the
• Auction date: September 5, 2008
• Auction settlement date: September 8, 2008*
• Notified Amount: Rs.1000 crore
* September 6 and 7 being holidays, settlement is done on
September 8, 2008 under T+1 cycle.
K.E.S. SHROFF COLLEGE Page 14
Details of bids received in the increasing order of bid yields
Bid No. Bid Yield
of bid (Rs.
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 100.00
6 8.22% 100 1100 100.00
7 8.23% 150 1250 99.93
8 8.24% 100 1350 99.87
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.
*Price corresponding to the yield is determined as per the relationship given
under YTM calculation in question 19.
ii. Price Based Auction: A price based auctionis conducted
when Government of India re-issues securities already issued earlier. Bidders
quote in terms of price per Rs.100 of face value of the security (e.g., Rs.101.02,
Rs.100.95, Rs.99.80, etc., per Rs.100/-). Bids are arranged in descending order and the
successful bidders are those who have bid at or above the cut-off price. Bids which are
below the cut-off price are rejected. An illustrative example of price based auction is given
Price based auction of an existing security 8.24% GS 2018
• Maturity Date: April 22, 2018
• Coupon: 8.24%
• Auction date: September 5, 2008
• Auction settlement date: September 8, 2008*
• Notified Amount: Rs.1000 crore
* September 6 and 7 being holidays, settlement is done on September 8,
2008 under T+1 cycle.
K.E.S. SHROFF COLLEGE Page 15
Details of bids received in the decreasing order of bid price
Price of bid
Amount of bid (Rs.
Crore) Implicit yield Cumulative 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
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 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.
Depending upon the method of allocation to successful bidders, auction could be classified
as Uniform Price based and Multiple Price based. In a Uniform Price auction, all the
successful bidders are required to pay for the allotted quantity of securities at the same rate,
i.e., at the auction cut-off rate, irrespective of the rate quoted by them. On the other hand,
in a Multiple Price auction, the successful bidders are required to pay for the allotted
quantity of securities at the respective price / yield at which they have bid. In the example
under (ii) above, if the auction was Uniform Price based, all bidders would get allotment
at the cut-off price, i.e., Rs.100.20. On the other hand, if the auction was Multiple Price
based, each bidder would get the allotment at the price he/ she has bid, i.e., bidder 1 at
Rs.100.31, bidder 2 at Rs.100.26 and so on.
K.E.S. SHROFF COLLEGE Page 16
An investor may bid in an auction under either of the following
i. Competitive Bidding: In a competitive bidding, an investor bids at a specific price /
yield and is allotted securities if the price / yield quoted is within the cut-off price / yield.
Competitive bids are made by well informed investors such as banks, financial institutions,
primary dealers, mutual funds, and insurance companies. The minimum bid amount is
Rs.10,000 and in multiples of Rs.10,000 thereafter. Multiple bidding is also allowed,
i.e., an investor may put in several bids at various price/ yield levels.
ii. Non-Competitive Bidding: With a view to providing retail investors an
opportunity to participate in the auction process, the scheme of non-competitive bidding
in dated securities was introduced in January 2002. Non-competitive bidding is open
to individuals, HUFs, RRBs, co-operative banks, firms, companies, corporate bodies,
institutions, provident funds, and trusts. Under the scheme, eligible investors apply for a
certain amount of securities in an auction without mentioning a specific price / yield.
Such bidders are allotted securities at the weighted average price / yield of the auction.
In the illustration given under 4.1 (ii) above, the notified amount being Rs.1000 crore, the
amount reserved for non- competitive bidding will be Rs.50 crore (5% of the
notified amount). Non- competitive bidders will be allotted at the weighted average
price which is Rs.100.26 in the given illustration. The participants in non-competitive
bidding are, however, required to hold a gilt account with a bank or PD. Regional Rural
Banks and co-operative banks which hold SGL and Current Account with the RBI can,
also, participate under the scheme of non-competitive bidding without holding a gilt
In every auction of dated securities, a maximum of 5 per cent of the notified amount is
reserved for non-competitive bids. In the case of auction for Treasury Bills, the amount
accepted for non-competitive bids is over and above the notified amount and there is no
limit placed. However, non-competitive bidding in Treasury Bills is available only to State
Governmentsand other select entities and is not available to the co-operative banks. Only one
bid is allowed to be submitted by an investor either through a bank or Primary Dealer. For
bidding under the scheme, an investor has to fill in an undertaking and send it along with
the application for allotment of securities through a bank or a Primary Dealer. The
minimum amount and the maximum amount for a single bid is Rs.10, 000 and Rs.2 crore
respectively in the case of an auction of dated securities. A bank or a Primary Dealer can
charge an investor up to maximum of 6 paisa per Rs.100 of application money as
commission for rendering their services. In case the total applications received for non-
competitive bids exceed the ceiling of 5 per cent of the notified amount of the auction for
dated securities, the bidders are allotted securities on a pro-rata basis.
K.E.S. SHROFF COLLEGE Page 17
PARTICIPANTS IN THE
GOVERNMENT SECURITIES MARKET
Government securities are approved securities for the purpose of statutory liquidity
requirements of banks. Banks, therefore, have been traditionally the largest holders of
Government securities. Though the SLR has been progressively reduced to 25% (of the net
demand and time liabilities of bank), it is estimated that banks hold about 37% (of the net
demand and time liabilities of banks) in the form of Government securities. Banks hold about
60% of outstanding Government Securities.
Apart from banks, provident funds and insurance companies are large holders of
Government bonds, buying them to comply with prudential norms governing their portfolios.
These institutions hold about 20% of outstanding Government Securities.
Primary Dealers hold Government securities either due to development or
underwriting commitments or to enable repo transactions and market making. Other investors
include mutual funds, individuals, charitable trusts etc.
Primary Issuance Process:
The issue of Government securities is governed by the terms and conditions specified
in the general notification of the Government and also the terms and conditions specified in
the specific notification issued in respect of issue of each security.
Who can apply:
Any person including firm, company, corporate body, institution, state government,
provident fund, trust, NRI, OCB predominantly owned by NRIs and FII registered with SEBI
and approved by RBI can submit offers, including in electronic form, for purchase of
For Central Government securities, the minimum denomination is Rs. 10000 and
trading takes place in multiples of Rs. 5 crores. For state Government securities, it is Rs. 1000
and trading takes place in multiples of Rs. 1-5 crores. For agency bonds, it is Rs.5000 and in
Mode of payment:
Payments for the securities are made by the applicants on such dates as mentioned in
the specific notification, by means of cash or cheque drawn on RBI or Banker‟s pay order or
by authority to debit their current account with RBI or by Electronic Fund Transfer in a
K.E.S. SHROFF COLLEGE Page 18
MMAANNNNEERR OOFF IISSSSUUEE OOFF GGOOVVEERRNNMMEENNTT SSEECCUURRIITTIIEESS
As a part of reform in the financial sector a policy decision was taken to move
towards market related interest rates for Government borrowing. Accordingly, with effect
from June 1992 Government of India has started borrowing by issue of debt at market related
rates determined by conducting auctions. Market related rates are evolved in the auctions for
sale of dated securities or treasury bills.
The Government issues securities through the following modes:
i. Issue of securities through auction.
ii. Issue of securities with pre-announced coupon rates.
iii. Issue of securities through tap sale.
iv. Issue of securities through conversion.
The Securities can be issued through auction either on price basis or yield basis. The
coupons on such securities are announced before the date of floation and the securities are
issued at par. No aggregate amount is indicated in the notification in respect of the securities
sold on tap. The holders of Treasury bills of certain specified maturities and holder of
specified dated securities are provided an option to convert the respective Treasury bills or
dated securities at specified prices into new securities offered for sale.
1) Issue of securities through auction.
Securities are issued through auction either on price basis or on yield basis. Where the
issue is on price basis, the coupon is predetermined and the bidders quote price per Rs. 100
face value of the security, at which they desire to purchase the security. Where the issue is on
yield basis, the coupon of the security is decided in an auction and the security carries the
same coupon till maturity. On the basis of the bids received, RBI determines the maximum
rate of yield or the minimum offer price as the case may be at which offers for purchase of
securities would be accepted at the auction. The RBI has moved from yield based auction to
price based auction in 1998, though it retains the flexibility to resort to yield based auctions
and notify the same in the auction notification.
The auctions for issue of securities (on either yield basis or price basis) are held either
on “Uniform price” (also known as Dutch auction) method or on “Multiple price” (also
known as French auction) method.
K.E.S. SHROFF COLLEGE Page 19
Where an auction is held on a “Uniform price” method, competitive bids offered with
rates up to and including the maximum rate of yield or the prices up to and including the
minimum offer price, as determined by RBI, are accepted at the maximum rate of yield or
minimum offer price so determined. Bids quoted higher than the maximum rate of yield or
lower than the minimum price are rejected. Where an auction is held on “Multiple prices”
method, competitive bids offered at the maximum rate of yield or the minimum offer price, as
determined by RBI, are accepted. Other bids tendered at lower than the maximum rate of
yield or higher than the minimum offer price are accepted at the rate of yield or price as
quoted in the respective bid. Bids quoted higher than the maximum rate of yield or lower than
the minimum price are rejected.
Individuals and specified institutions (retail investor) can participate in the auctions on
“non-competitive” basis. Allocation of the securities to non-competitive bidders is made at
the discretion of RBI and at a price not higher than the weighted average price arrived at on
the basis of the competitive bids accepted at the auction or any other price announced in the
specific notification. The nominal amount of securities that would be allocated to retail
investors on non-competitive basis is restricted to a maximum percentage of the aggregate
nominal amount of the issue, within or outside the nominal amount.
Sale of Government securities (except 91 days treasury bills) is held under Multiple
Price Auctions; Uniform Price Auctions are held for sale of 91 days Treasury Bills. RBI has
announced that it may conduct uniform price auctions for sale of dated securities on a
selective and experimental basis. The notification for the respective auctions will specify the
format to be used, viz., uniform price or multiple prices.
2) Issue of securities with pre-announced coupon rates.
The coupon on such securities is announced before the date of flotation and the
securities are issued at par. In case the total subscription exceeds the aggregate amount
offered for sale, RBI may make partial allotment to all the applicants. State Governments
continue to issue securities at pre-announced coupon rates and prices. However, from
1998-99 onwards an option was given to the State Government to raise a small portion of
their borrowing by conducting competitive auctions. Several State Governments have availed
of this facility.
3) Issue of securities through tap sale.
No aggregate amount is indicated in the notification in respect of the securities sold on
tap. Sale of such securities may be extended to more than one day and the sale may be closed
at any time on any day.
K.E.S. SHROFF COLLEGE Page 20
4) Issue of securities on conversion of maturing treasury bills/dated
The holders of treasury bills of certain specified maturities and holders of specified
dated securities are provided with an option to convert their holding at specified prices into
new securities offered for sale. The new securities could be issued on an auction/pre-
announced coupon basis.
In what form can Government Securities be held and the trading of Government
securities take place?
Government security held in following ways :
5.1 The Public Debt Office (PDO) of the Reserve Bank of India, Mumbai acts as the
registry and central depository for the Government securities. Government securities may
be held by investors either as physical stock or in dematerialized form. From May 20,
2002, it is mandatory for all the RBI regulated entities to hold and t r a n s a c t i n
G o v e r n m e n t s e c u r i t i e s o n l y i n dematerialized ( SGL) f o r m .
Accordingly, UCBs are required to hold all Government securities in demat form.
a. Physical form: Government securities may be held in the form of stock
certificates. A stock certificate is registered in the books of PDO. Ownership in stock
certificates cannot be transferred by way of endorsement and delivery. They are
transferred by executing a transfer form as the ownership and transfer details are recorded
in the books of PDO. The transfer of a stock certificate is final and valid only when the
same is registered in the books of PDO.
b. Demat form: Holding government securities in the dematerialized or scrip less form
is the safest and the most convenient alternative as it eliminates the problems
relating to custody, viz., and loss of security. Besides, transfers and servicing are
electronic and hassle free. The holders can maintain their
securities in dematerialised form in either of the two ways:
i. SGL Account: Reserve Bank of India offers Subsidiary General Ledger
Account (SGL) facility to select entities who can maintain their securities in SGL
accounts maintained with the Public Debt Offices, of the Reserve Bank of
ii. Gilt Account: As the eligibility to open and maintain an SGL account with the
RBI is restricted, an investor has the option of opening a Gilt Account with a
bank or a Primary Dealer which is eligible to open a Constituents' Subsidiary
General Ledger Account (CSGL) with the RBI. Under this arrangement, the
bank or the Primary Dealer would maintain the holdings of its constituents in a
CSGL account (which is also known as SGL II account) with the RBI as a
custodian on behalf of the Gilt Account holders. The servicing of securities held
in the Gilt Accounts is done electronically, facilitating hassle free trading and
maintenance of the securities. Receipt of maturity proceeds and periodic interest
is also faster as the proceeds are credited to the current account of the custodian
K.E.S. SHROFF COLLEGE Page 21
bank / PD with the RBI and the custodian (CSGL account holder) immediately
passes on the credit to the Gilt Account Holders (GAH).
5.2 Investors also have the option of holding Government securities in a
dematerialized account with a depository (NSDL / CDSL, etc.). This facilitates trading
of Government securities on the stock exchanges.
How does the trading in Government securities take place?
There is an active secondary market in Government securities. The securities can be
bought / sold in the secondary market either (i) Over the Counter (OTC) or (ii) through
the Negotiated Dealing System (NDS) or (iii) the Negotiated Dealing System-Order
I. Over the Counter (OTC)/ Telephone Market
6.2 In this market, a participant, who wants to buy or sell a government security, 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. In the case of a buyer, like an urban
co-operative bank wishing to buy or sell a security, the bank's dealer (who is authorized
by the bank to undertake transactions in Government Securities) may get in touch
with other market participants over telephone and obtain quotes. Should a deal be
struck, the bank should record the details of the trade in a deal slip (specimen given at
Annex 3) and send a trade confirmation to the counterparty. The dealer must exercise
due diligence with regard to the price quoted by verifying with available sources
(See question number 12 for information on ascertaining the price of Government
securities). All trades undertaken in OTC market are reported on the secondary market
module of the NDS, the details of which are given under the question number 13.
ii. Negotiated Dealing System
6.3 The Negotiated Dealing System (NDS) for electronic dealing and reporting of
transactions in government securi t i es w as i nt roduced i n Febr uar y 2002 . It
facilitates the members to submit electronically, bids or applications for primary
Issuance of Government Securities when auctions are conducted. NDS also
provides an interface to the Securities Settlement System (SSS) of the Public Debt Office,
RBI, Mumbai thereby facilitating settlement of transactions in Government Securities
(both outright and repos) conducted in the secondary market.
Membership to the NDS is restricted to members holding SGL and/or Current Account
with the RBI, Mumbai.
K.E.S. SHROFF COLLEGE Page 22
6.4 In August, 2005, RBI introduced an anonymous screen based order matching module
on NDS, called NDS-OM. This is an order driven electronic system, where the
participants can trade anonymously by placing their orders on the system or accepting
the orders already placed by other participants. NDS-OM is operated by the Clearing
Corporation of India Ltd. (CCIL) on behalf of the RBI (Please see answer to the question
no.15 about CCIL). Direct access to the NDS-OM system is currently available only to
select financial institutions like Commercial Banks, Primary Dealers, Insurance
Companies, Mutual Funds, etc. Other participants can access this system through their
custodians, i.e., with whom they maintain Gilt Accounts. The custodians place the orders
on behalf of their customers like the urban co-operative banks. The advantages of NDS-
OM are price transparency and better price discovery.
6.5 Gilt Account holders have been given indirect access to NDS through
custodian institutions. A member (who has the direct access) can report on the NDS the
transaction of a Gilt Account holder in government securities. Similarly, Gilt Account
holders have also been given indirect access to NDS-OM through the custodians.
However, currently two gilt account holders of the same custodian are not permitted to
undertake repo transactions between themselves.
iii. Stock Exchanges
Facilities are also available for trading in Government securities on stock exchanges
(NSE, BSE) which cater to the needs of retail investors
K.E.S. SHROFF COLLEGE Page 23
SSTTAATTUUTTOORRYY PPRROOVVIISSIIOONNSS FFOORR RREEGGUULLAATTIIOONN OOFF
GGOOVVEERRNNMMEENNTT SSEECCUURRIITTIIEESS MMAARRKKEETT
1) Primary Market
The Reserve Bank of India manages the public debt and issues new loans on behalf of
central government in terms of Sections 20 and 21 of the Reserve Bank of India Act, 1934.
The Bank manages the public debt of State Government as per agreements entered into with
the state government concerned (Sec.21A of the Act). Bank has entered into agreement with
28 state governments for management of their public debt. Further, in terms of Public Debt
Act, 1944, the administration of public debt devolves on the Bank.
Consequently the Reserve Bank has been taking all initiatives for development of a
market for government securities, which would facilitate price discovery and provide
liquidity to government securities. In brief, these initiatives mainly involved the promotion of
institutional infrastructure and legal reforms relating to the manner of issue and custody of
government debt instruments and their transfer and settlement.
The public debt management covers the issue, interest payment and repayment of
rupee loan, and all matters pertaining to government debt certificates including registration,
custody, transfer, conversion, sub-division etc. of government debt holdings. The 15 public
debt offices of the Reserve Bank functioning at various centers attend to these functions. In
addition, as manager of public debt, Bank has to advise the Government regarding the size of
borrowing, timing of issue of new loans etc.
Mode of holding & transfer of Government Securities:
Government securities can be issued basically in three forms, viz., Government
Promissory Notes, Stock or any other form as may be notified by the Central government.
Promissory notes are in the physical form where as stock can be either in the physical form
called "Stock Certificate" or "Book Debt Certificate" or in a book entry form called
"Subsidiary General Ledger Account (SGL Account)".
SGL Account which provides a secure and convenient form of holding is permitted to
be opened at public Debt Offices only by institutions which maintain current account with
RBI. Others can also enjoy the benefit of SGL Account form of holding by availing of the
custodial services extended by banks and Primary Dealers maintaining SGL Account with
PDOs. In order to segregate the custodial holdings from their own investments, SGL Account
holders are allowed to maintain one more SGL Account with PDOs called "Constituents' SGL
Account". While maintaining and operating such constituents' account, SGL Account holders
are required to abide by the "Guidelines for Maintaining Constituents SGL Account" which
have been issued by RBI.
K.E.S. SHROFF COLLEGE Page 24
The holder of the security can affect transfer of Government securities by completing
the prescribed transfer form. The transfer will be complete only when the ownership of the
security is changed in the name of the transferee in the books of the Public Debt Office. The
transferee of securities should tender the SGL transfer form latest by the day following the
deal to facilitate T+1 basis for settlement. In respect of securities held in the form of SGL
Account transfer takes place in the books of Public Debt Offices on Delivery Versus payment
(DVP) basis. DVP system is introduced to reduce the counter party risk in securities
2) Secondary Market
Transactions in securities are governed by the Securities Contracts (Regulation) Act,
1956 as government securities are "Securities" as defined in the Act. Hence the provisions of
the Act are applicable for the transactions in Government securities. Under the Act the
Reserve Bank has been delegated powers by the Government of India to regulate contracts in
government securities, money market securities, gold related securities and derivatives based
on these securities, as also ready forward contracts in all debt instruments. Transactions on
the stock exchanges will be in addition subject to the regulations prescribed by the Securities
& Exchange Board of India (SEBI).
Reserve Bank of India has permitted Repos and Reverse Repos subject to the terms
and conditions and among the participants as specified hereunder:
1) Ready forward contracts are undertaken only in Treasury Bills and transferable dated
securities of all maturities issued by the Government of India and State Governments.
2) Ready forward contracts in the securities specified at (a) above may be entered into by
a banking company, a cooperative bank or any person, maintaining a Subsidiary
Ledger Account and a Current Account with Reserve Bank of India, Mumbai, only
3) Such ready forward contracts shall be settled through the Subsidiary General Ledger
Accounts of the participants with Reserve Bank of India at Mumbai only, and
4) No sale transaction should be put through without actually holding the securities in
While RBIs policy supports the establishment of a deep and liquid repo market,
enlargement of the types of securities and eligible participants for the repo market will
depend upon the establishment of the secure infrastructure for the securities market including
establishment of a Securities Clearing Corporation to facilitate tri-partite repos.
Short selling in securities is prohibited. Presently, Over- the -Counter outright
transactions in government securities can be freely concluded providing for spot delivery
(payment on the same day of the contract or next day) as per the Act.
K.E.S. SHROFF COLLEGE Page 25
In order to develop the securities market on healthy lines and to facilitate price
discovery in the market, RBI daily makes available to the market the prices in respect of
secondary market transactions in government securities, which are settled through SGL
Account. This has helped in the establishment of sovereign yield curve, promoted market
transparency and improved price discovery for government securities in the Indian Market.
Effective management of public debt by the Reserve Bank is closely linked to the
development of a deep and liquid secondary market and RBI has been taking various
initiatives in this direction.
K.E.S. SHROFF COLLEGE Page 26
GGOOVVEERRNNMMEENNTT SSEECCUURRIITTIIEESS-- MMAARRKKEETT SSTTRRUUCCTTUURREE
From a narrow ownership base, Government securities market has been increasingly
becoming broad-based over the recent years. The main holders of government securities are
banks, Primary/Satellite Dealers, LIC, All India Financial Institutions, Provident Fund Trusts,
Gilt Funds and lastly corporate entities and retail holders, mainly through Mutual Funds.
Although Foreign Institutional Investors are allowed to invest in government securities such
investments have not picked up. A large part of outstanding government securities are held by
the Reserve Bank mainly as back up for its currency issue liabilities and for conducting Open
Market Operations. Introduction of the system of Primary Dealers have ensured that
underwriting of the primary issues is shouldered mainly by Primary Dealers and automatic
devolvement on RBI does not happen.
The main participants in the Government Securities market such as banks, Primary
Dealers, Financial Institutions enter into transactions in government securities market mainly
as a part of their investment and trading functions. RBI has issued detailed instructions to
banks about the categorization and valuation of government securities. Further banks, which
maintain "Trading Book", can do so, only subject to compliance with certain preconditions
specified by the RBI from risk management angle.
In order to develop the market on sound lines, RBI has initiated various reforms. Thus
the prices at which different securities are bought/sold are made available to the market
participants on a daily basis. National Stock Exchange also publishes the security prices in
transactions reported to them. As mentioned earlier system of DVP has been introduced to
reduce counterparty risk in security transfers.
In order to protect the interest of retail holders of government securities using the
system of Constituents SGL Accounts, RBI have issued guidelines regarding maintenance of
such accounts. A system of retail holding through Bond Ledger Form has also been
introduced in respect of certain securities. Bond Ledger Accounts can be opened with
branches of specified banks and this is expected to make it convenient for retail holders,
although at present only Relief Bonds can be so held.
RBI extends liquidity support to Mutual Funds Dedicated to Investments in
Government Securities (GILT FUNDS) to encourage such Mutual Funds, which is a
convenient way of indirect investments in government securities by individuals and other
Primary Dealers play an important role in the government securities market. A brief
account of their role is provided in the following paragraphs:
K.E.S. SHROFF COLLEGE Page 27
The Guidelines for Primary Dealers (PDs) in Government Securities were announced by the
Bank in March 1995. The objectives of setting up the system of Primary Dealers are:
i. To strengthen the infrastructure in the government securities market in order to make
it vibrant, liquid and broad based.
ii. To ensure development of underwriting and market making capabilities for
government securities outside the RBI so that the latter will gradually shed these
iii. To improve secondary market trading system, which would contribute to price
discovery, enhance liquidity and turnover and encourage voluntary holding of
government securities amongst a wider investor base.
iv. To make PDs an effective conduit for conducting open market operations.
Eligibility for being considered for Primary Dealership
The following are the eligibility standards:
i. The entity should be a subsidiary of a scheduled commercial bank/an All India
Financial Institution dedicated predominantly to the securities business and in
particular to the government securities market, or a company incorporated under the
Companies Act, 1956 and engaged predominantly in the securities business and in
particular the government securities market, and
ii. The applicant should have Net owned funds of a minimum of Rs.50 crore.
Three basic parameters would have to be necessarily fulfilled by an applicant for PD-
ship, i.e., the company should have (a) net owned funds of Rs.50 crore (b) sizeable business
in government securities and (c) should not be a loss making company.
The relationship between the Bank and the entities in their capacity as PDs is not
statutory, but contractual in nature. Primary Dealership is renewed every year on the basis of
agreement to be entered into between the Bank and these entities. Legally they are non-
banking financial companies and are subject to the registration requirements for NBFCs.
However, if a PD does not accept public deposits it is exempt from the related regulations. On
account of the special responsibilities assigned to them in the Government Securities Market,
RBI has been monitoring their activities by undertaking off as well as on site surveillance
through scrutiny of prescribed returns and also by on-site inspections to check compliance
with the Guidelines and other terms of appointment. RBI has prescribed capital adequacy
standards to be observed by Primary Dealers. The Primary Dealers' responsibilities are:
i. A Primary Dealer will be required to commit to aggregative bid for Government of
India dated securities and auction Treasury Bills on an annual basis of not less than a
specified amount. The agreed minimum amount of bids would be separately indicated
for dated securities and Treasury Bills.
ii. The Primary Dealer would have to achieve a minimum success ratio of 40 per cent for
both dated securities and Treasury Bills (vis-à-vis bidding commitment).
K.E.S. SHROFF COLLEGE Page 28
iii. To maintain risk based capital adequacy as per RBI instructions
iv. The PD has to quote two-way at least in a few securities
v. PDs have to underwrite primary auction of government securities.
Issues of Treasury Bills are not underwritten. Instead, PDs have to commit to submit
minimum bids at each auction covering the entire issue amounts.
The percentage of minimum bidding commitment so determined by the Reserve Bank
will remain unchanged for the entire financial year. In determining the minimum bidding
commitment, RBI will take into account the offer made by the PD, its net owned funds and its
Facilities extended to the PDs
The following facilities have been extended to PDs:
i. Entitlement to open one Current Account and two Subsidiary General Ledger (SGL)
Accounts for government securities (one for own operations and the second for
operations on behalf of constituents), at all offices of the RBI.
ii. Permission to borrow and lend in the money market including call money market and
to trade in all money market instruments.
iii. Liquidity Support through Repos operations/demand loans with RBI collateralised by
Central Government dated securities and Auction Treasury Bills up to the limit fixed
iv. Favoured access to Open Market Operations.
v. Permission to raise Commercial Paper as per the provisions contained in the "Primary
Dealers (Acceptance of Deposits through Commercial Paper) Directions, 1996" issued
in terms of Section 45 K and 45 L of the RBI Act, 1934.
vi. Facility of transfer of funds from one centre to another centre under RBIs Remittance
Facility Scheme and also of clearing of cheques arising out of Government securities
transactions, tendered at RBI counters.
Other Obligations of PDs
The following important obligations are cast on them under the PD Guidelines:
i. Obligation to offer a firm two-way quotes for government securities and take principal
ii. Achieving prescribed turn over ratios in government securities.
iii. Maintenance of physical infrastructure in terms of office, computing equipment,
communication facilities like Telex/Fax, Telephone, etc., and skilled manpower for
efficient participation in primary issues, trading in the secondary market, and to
provide advice and education to investors.
K.E.S. SHROFF COLLEGE Page 29
iv. Putting in place efficient internal control system.
v. Obligation to provide to RBI access to all records, books, information and documents
as may be required.
vi. Adherence to all prudential and regulatory guidelines prescribed by RBI from time to
vii. Formation of self regulatory organisation (SRO).
viii. Maintenance of a separate desk for government securities business and separate
accounts and has an external audit of annual accounts.
ix. Maintenance separate accounts in respect of its own position and customer
x. Responsibility to bring to RBIs attention any major complaint against him or action
initiated/taken against him by authorities such as the Stock Exchanges, SEBI, CBI,
Enforcement Directorate, Income Tax, etc.
xi. Setting up prudential ceilings, with the prior approval of the Board of Directors of the
company, on borrowings from the money market including repos, as a multiple of net
owned funds, subject to the guidelines, if any, issued by the Reserve Bank in this
K.E.S. SHROFF COLLEGE Page 30
RROOLLEE OOFF MMAARRKKEETT IINN GGOOVVEERRNNMMEENNTT FFIINNAANNCCEE
Government Securities are unique and important financial instruments in the financial
market. Except, Treasury bills all other instruments are held by the Reserve Bank of India.
The techniques of open market operations and statutory liquidity ratio are closely connected
with the dynamics of the market for these instruments. The issues of Government Securities
are helpful in implementing the fiscal policy of the Government. Financial Institutions like
commercial banks are required to maintain their secondary reserve requirements in the form
of government securities. They can obtain accommodation from the RBI against the collateral
of these securities. As Government Securities are claims on the Government, They are
absolutely secured financial instruments, which guarantee the certainty of income as well as
Therefore, they are called gilt-edged securities. Interest on Government Securities is
payable half-yearly. Interest on Government
Securities along with income in the form of interest or dividends on other approved
investments is exempt from income-tax subject to a certain limit. Individuals normally do not
invest in these securities, saving in tax liability does not seem to be an important motivation
behind investment in these securities. Government Securities are safe and liquid. But different
authorities issue the Government Securities, hence the extent to which they possess these
attributes, the safety and liquidity differ from authority to authority. The marketability of
Government securities is relatively restricted. There is no active market for Government
Securities, particularly in semi-government securities.
There are three forms of Central and State Government Securities:
i. Stock Certificates.
ii. Promissory Notes.
iii. Bearer Bonds.
Bearer bonds are not usually issued and Stock Certificates are not popular in India.
Most of the government securities currently are in the form of Promissory notes. Promissory
notes of any loan can be converted into stock Certificates of any other loan and vice versa.
Government Securities are issued through the Public Debt office of the Reserve Bank
of India. The issues of Government Securities are notified a few days before they become
open for subscription and they are kept open for subscription for 2 to 3 days. These issues
may be closed for subscription earlier if the subscriptions approximate the amount of issue.
The budgeted amount of the issues in a given year is raised in a number of branches in
the year. This is done for the purpose of avoiding the flooding of the market with securities at
a given time. There are small member of large issues, because the issues are mostly bought by
the institutional investors. After the announcement of the new issue, the RBI suspends the
sale of existing loans till the closure of subscription for the new issues. The Government
reserves the right to retain subscriptions up to a specified percentage i.e. up to 10 percent in
excess of notified amounts. Applications for loans are collected by the offices of the RBI and
SBI. In case of issues of State Government Securities, over-subscription to loans of one
K.E.S. SHROFF COLLEGE Page 31
Government is transferable to the other government, whose loan is still open for subscription,
at the option of the subscriber. These are mostly concentrated in the slack seasons.
Types of Trading:
The RBI practices the dealing in Government Securities in the following manner:
a) Grooming: Grooming is the gradual acquisition of securities by the RBI, which are
nearing maturity through the Stock Exchanges. It is done in order to facilitate redemption.
The object is to keep the process of issue and redemption of Government Securities
contineous and thereby facilitate availability of the securities on „tap‟
b) Switching: The Purchases of one security and Sale of another securities carried out by the
RBI in the secondary market as part of its open market operations is known as
„Switching‟. It helps the banks and financial institutions to improve the yield on their
investments in securities. The
RBI also fixes an annual quota for the Switch Transactions of each institution.
c) Auctioning: Auctioning is a method of trading whereby merchants bid against one
another and the securities are sold to the highest bidder. This system was introduced in
1992. Under this mechanism a number of instruments of wide trading period are sold. The
period ranges from 14 days to 364 days. The Bidders give written and sealed quotations
which are restricted to notified amounts. There are two types of auction, multiple price
auctions and uniform price auction. Under the multiple price auction every bidder gets
allocation according to his bid and the issuer collect the premium from all the bidders by
quoting a rate lower than the cut-off yield. Under the uniform price auction, competitive
bids are accepted on the basis of the minimum discounted price known as cut-off-price.
The price is determined at the auction. The minimum price is independent of the bid
prices tendered below or at the cut-off-price.
K.E.S. SHROFF COLLEGE Page 32
Trading mechanism in Government Securities carried out under the following
i. Direct Sales: Under this method, Public Debt effect direct sale of securities. The loan
amounts are pre-specified and the dates of opening of subscription for Government loans
are also specified.
ii. SGL Account Method: Under this method RBI records the transactions as book entries
only in the Securities General Ledger (SGL). The date and value of transaction are
recorded. The purchasing banker maintains a separate SGL account for each dealing with
the RBI in respect of its purchases of securities. The selling banker also effects his
transactions by filling out the prescribed SGL form, which is then lodged with the RBI. It
helps to the banks to know their day to day balances.
iii. Banker’s Receipt: Under this method, the bank selling Government Securities issues a
Bank Receipt. There are facilities for SGL where physical transfer can be avoided. This is
done in case of „repo‟ or ready forward transactions. It is a sale transaction, which buys
back the securities at a stipulated future date at a price determined on the date of sale
transaction. Under the „repo‟ short operations are conducted by banks which Sell
government securities without owning them with a view to neutralizing the transaction by
buying them at a later date.
SECONDARY MARKET TRANSACTIONS:
In order to encourage wider participation of all classes of investors across the country
in Government Securities, the Government RBI and SEBI have introduced trading in
Government Securities thorough a nationwide, anonymous order drives screen based trading
system of Stock Exchanges. This facility is in addition to the Present system of dealing in
Government Securities through the Negotiated Dealing System of the RBI. This measure can
help in reducing time and cost in trade execution by matching orders on a strict price-time
priority. It will also expand the investor base and provide country-wide access to the
Government Securities market.
It is also expected to enhance the operational and informational efficiency of the
market as well as the transparency depth and liquidity.
The Participation in the Secondary market in Government Securities is restricted to
banks, financial institutions, Mutual funds, Foreign Institutional Investors and Trusts. There
is no country-wide access for retail participation. The trades are done through negotiations,
with the knowledge of counter parties and usually over the phone rather than the trades being
matched on an anonymous automated price time priority mechanism.
K.E.S. SHROFF COLLEGE Page 33
At present most of the Secondary market trades in Government Securities take place
thorough bilateral negotiations. It is essentially a telephone market where the deals are
negotiated directly by counter parties who are usually banks and other financial institutions or
brokers. Since February, 2002, the RBI is providing an electric platform called Negotiated
Dealing System (NDS) for facilitated negotiated dealings in Government Securities. The
NDS also provides an interface to the Securities Settlement System of the Public Debt office
of the RBI. All outright trades in Government Securities done or reported on the NDS have
the facility of guaranteed settlement extended by the Clearing Corporation of India Limited
(CCIL) through the process of novation. Only the NDS members can route their deals done
among themselves for settlement through the CCIL. Outright transactions in Government
Securities for Cut-off amount of Rs. 20 crores and below (face value) and all „repo‟ trades are
settled through the CCIL. For outright transactions of face value above Rs. 20 crores option is
available to members to settle either directly through the RBI-SGL or through the CCIL. For
outright transactions of face value above Rs. 20 crores option is available to members to settle
either directly through the RBI-SGL or through the CCIL. The objective of the NDS is to
provide online price information of transactions in Government Securities.RBI has also
permitted the banks and financial institutions to transact in debt instruments among
themselves or with non-bank clients through the member of the NSE, BSE, and OTCEI. The
NSE provides a separate wholesale Debt Market Segment.
K.E.S. SHROFF COLLEGE Page 34
IIMMPPLLIICCAATTIIOONNSS FFOORR MMOONNEETTAARRYY PPOOLLIICCYY
An important part of monetary management is the management of Government
Securities market. The Reserve Bank of India can execute its interest rate policy through
changes in the Bank Rate, by fixing interest rates on government borrowing and lending and
by influencing the behavior of price and yields in the gilt-edged market.
The management of gilt-edged market has also a considerable bearing on the advances
and liquidity of commercial bank so as to help the monetary policy. Another objective is to
ensure that suitable and inexpensive finance for the exchequer is available and will continue
to be available in future. The prices of Government Securities have been maintained at a
remarkable stable level during the past. The rates of interest on Government Securities have
been raised much less than those another claims in the economy.
The open market operations have not been used much for influencing the cost and
availability of credit. They have been employed by the RBI primarily to assist the
Government in their borrowing operations and to maintain orderly conditions in the market.
The size of debt is a function of macro-economic policy and there is on ongoing
dialogue between RBI and the Government on the issue. The size of market borrow in has an
impact on the interest rates, as large-scale pre-emption of resources by the government puts
pressure on liquidity in the market and as a result interest rates tend to go up. RBI‟s exclusive
role becomes important in the matter of short-term liquidity management in the financial
system. World over Central banks operate in the Short-term market to influence liquidity
conditions so that short-term interest rates, do not unduly impact the medium and long-term
interest rated in the economy.
In the USA and UK, open market operations in government securities for the purpose
of monetary management have become limited with the growth of government debt. A
combination of policies of trading in treasury bills for monetary management and in the
Government Securities for debt management is adopted by them. In India, treading in
treasury bills is also used for the purpose of government financing. It has not been used
actively for affecting bank reserves. Favorable conditions in the Government Securities
market cannot be maintained merely by not varying interest rates on Government Securities.
It also requires the rejection of the traditional monetary policy, which relies on Bank rate
variations to influence economic activity. In the free, market, variations in the Bank rate
ought to cause variations in interest rates on government Securities and their prices.
K.E.S. SHROFF COLLEGE Page 35
The RBI has been holding in its portfolio only Central government securities, as a
matter of policy.
The Government Securities held by it are partly held in the form of assets of the issue
department and partly in the banking department. The Securities held in Banking Department
are available for sale by the RBI under its open Market Operations.
The open market operations are conducted by way of purchase and sale of Central
Government Securities by the RBI on outright basis or on repo basis. The repo operations of
the RBI address the system liquidity is basically short term in nature and purchase and sale of
securities on outright basis is long-term in nature because it causes long-term changes in the
K.E.S. SHROFF COLLEGE Page 36
The RBI has undertaken reforms in the Government Securities Market. The RBI has
started providing liquidity support with regard to mutual funds that are dedicated exclusively
to investment in Government Securities. The purpose is to create an enhanced and wider
investor base for such securities. The support is made available to mutual funds to the extent
of 20 percent of outstanding investment in Government Securities, either by way of outright
purchase or reverses repos, Banks and selected entities are permitted to carry out Ready
Forward (REPO) transactions in government Securities.
As regards to „Market to Market‟ valuation of Government Securities, the ratio of
investment classified in current category for public sector banks has been raised from 40
percent to 50 percent and for the new private sector banks it has been fixed at 100 percent of
their investments. The RBI has extended the Delivery v/s payment system with regard to
auctioning of treasury bills with effect from February 14, 1996 to the banks. With effect from
October 21, 1997 all categories of foreign Institutional investors were allowed by the RBI to
make Investment in Government Securities that are registered with and approved by the SEBI
for making investments in gilt-edged securities has been permitted up to a ceiling of 30
percent in debt instruments. As per amended guidelines of June, 1998 equity funds were
permitted to invest in dated Government Securities and Treasury bills, both in Primary and
Secondary Markets within their 30 percent debt ceiling. Uniform price auction was
introduced on November 6, 1998 regarding the auction of 91 days Treasury bills on an
With effect from June, 23, 1998. Satellite Dealers were permitted to issue commercial
paper with maturity ranging from 15 days to one year. There were some conditions. The issue
should be made within a period of 2 months of obtaining credit rating and every renewal is
treated as a fresh issue. The issue should be made in the multiple of Rs. 5 lakhs with a
minimum of investment by a single investor being Rs. 25 lakhs. The aggregate limit is raised
within two weeks from the date of RBI approval and the issue is not underwritten or co-
accepted in any manner. The RBI and the Government have made arrangement for the setting
up of a clearing corporation to provide for the opening of the repo market to PSU bonds and
bonds of financial institutions held in demat form in depositories and traded in recognized
Stock Exchanges with essential safeguards.
K.E.S. SHROFF COLLEGE Page 37
RREEAADDYY FFOORRWWAARRDD CCOONNTTRRAACCTTSS ((RREEPPOOSS))
A transaction in which two parties agree to sell and repurchase the same security is
called „ready forward contract‟ or „Repos‟. It is also known as buyback deal. This
arrangement provides for the seller to sell specified securities with an agreement to
repurchase the same at a mutually pre-determined future date and price and the buyer to
purchase the securities with an agreement to resell the same at a predetermined future date
and the price.
Commercial Banks, Securities Dealers, DFHI, STCI, RBI, Cooperative Banks are
allowed to participate in the repos market. Non-bank finance companies LIC, GIC, UTI and
companies are also allowed to participate in this market from March, 2003. Repo transactions
are arranged over the counter by telephone either by direct contact or through a group of
market specialists. Repo transactions can be used in respect of CPs, CDs, Treasury Bills and
Government dated securities. National Stock Exchange can also be used for currying out repo
transactions. The Repo contract provides the seller-bank to get money by parting with its
security and the buyer-bank in turn to get the security by parting with its money. The prices
of sale and repurchase of securities are determined before entering into the deal.
Repos, being collateralized loans, help to reduce counter party risk and fetch a low
interest rate. It is possible to use repos as an effective hedge tool to arrange another repo or to
sell them outright or to deliver them to another party to fulfill a delivery commitment in
respect of a forward or future contract on a short sale. Repo is an almost risk-free instrument
used to even out liquidity changes in the system. It offers safe short-term outlet for temporary
excess cash at close to market interest rates. Repos are used to finance securities held in
trading and investment accounts of security dealers to establish short positions, to implement
arbitrage activities and meeting specific customer needs because of low-risk and flexible
short-term instruments. They also offer low-cost investment opportunities with combinations
of yields and liquidity. It is possible to enhance the safety of repo transaction by making the
security price to the market and by providing a margin on the security value. The Repo
arrangement serves as a short-term cash management tool. The RBI uses repos as a tool of
liquidity control for absorbing surplus-liquidity from the banking system in a flexible way
and thereby preventing interest rate arbitraging.
A Reverse Repo is the opposite of a repo transaction. It is a reverse purchase
agreement. The counter party enters into a reverse repurchase agreement and makes a short-
term collateralized loan to the bank, the primary dealer or the seller of securities. This is done
by providing funds in return for holding securities on the maturity of the reverse repurchase
transaction, the counter party returns the same security to the same bank and the primary
dealer receives back the funds from the buyer. The amount received by the buyer is the
principal plus interest. The interest is termed as the repo rate. This arrangement allows banks
to make efficient use of their funds.
K.E.S. SHROFF COLLEGE Page 38
DO'S AND DON’TS FOR CO-OPERATIVE BANKS
DEALING IN GOVERNMENT SECURITIES
• Segregate dealing and back-up functions. Officials deciding about
purchase and sale transactions should be separate from those
responsible for settlement and accounting.
• Monitor all transactions to see that delivery takes place on settlement day. The
funds account and investment account should be reconciled on the same day
before close of business.
• Keep a proper record of the SGL forms received/issued to facilitate counter-
checking by their internal control systems/RBI inspectors/other auditors.
• Seek a Scheduled Commercial Bank (SCB), a Primary Dealer (PD) or
a Financial Institution (FI) as counterparty for transactions.
• Give preference for direct deals with counter parties.
• Use CSGL/ Gilt Accounts for holding the securities and maintain such
accounts in the same bank with whom the cash account is maintained.
• Insist on Delivery versus Payment for all transactions.
• Take advantage of the non-competitive bidding facility for acquiring
Government of India securities in the primary auctions conducted by the Reserve
Bank of India.
• Restrict the role of the broker to that of bringing the two parties to the deal
together, if a deal is put through with the help of broker.
• Have a list of approved brokers. Utilize only brokers registered with NSE
or BSE or OTCEI for acting as intermediary.
• Place a limit of 5% of total transactions (both purchases and sales) entered into
by a bank during a year as the aggregate upper contract limit for each of the
approved brokers. A disproportionate part of the business should not be
transacted with or through one or a few brokers.
• Maintain and transact in Government securities only in dematerialized form
in SGL Account or Gilt Account maintained with the CSGL Account holder.
• Open and maintain only one Gilt or dematerialized account.
K.E.S. SHROFF COLLEGE Page 39
• Open a funds account for securities transactions with the same
Scheduled Commercial bank or the State Cooperative bank with whom the
Gilt Account is maintained.
• Ensure availability of clear funds in the designated funds accounts for purchases
and sufficient securities in the Gilt Account for sales before putting
through the transactions.
• Observe prudential limits for investment in permitted non-SLR securities
(bonds of nationalized banks, unlisted securities, unlisted shares of all-India
Financial Institutions and privately placed debt securities).
• The Board of Directors to peruse all investment transactions at least once a month
• Do not undertake any purchase/sale transactions with broking firms or
other intermediaries on principal to principal basis.
• Do not use brokers in the settlement process at all, i.e., both funds settlement
and delivery of securities should be done with the counter-parties directly.
• Do not give power of attorney or any other authorisation under any
circumstances to brokers/intermediaries to deal on your behalf in the money and
• Do not undertake Government Securities transaction in the physical form with
• Do not routinely make investments in non-SLR securities (e.g., corporate bonds,
issued by companies or bodies other than in the co-operative sector.
K.E.S. SHROFF COLLEGE Page 40
MONEY MARKET AND ROLE OF FIMMDA
While the Government securities market generally caters to the investors with a long term
investment horizon, the money market provides investment avenues of short term tenor.
Money market transactions are generally used for funding the transactions in other markets
including Government securities market and meeting short term liquidity mismatches. By
definition, money market is for a maximum tenor of up to one year. Within the one
year, depending upon the tenors, money market is classified into:
i. Overnight market - The tenor of transactions is one working day.
ii. Notice money market – The tenor of the transactions is from 2 days to 14 days. Iii.
Term money market – The tenor of the transactions is from 15 days to one year.
What are the different money market instruments?
Money market instruments include call money, repos, Treasury bills, Commercial
Papers, Certificate of Deposits and Collateralized Borrowing and Lending Obligations
Call money market
Call money market is a market for uncollateralized lending and borrowing of funds. This
market is predominantly overnight and is open for participation only to scheduled
commercial banks and the primary dealers.
Repo or ready forward contact is an instrument for borrowing funds by selling securities
with an agreement to repurchase the said securities on a mutually agreed future date
at an agreed price which includes interest for the funds borrowed.
The reverse of this transactions is called „reverse repo‟ which is lending of funds against
buying of securities with an agreement to resell the said securities on a mutually agreed
future date at an agreed price which includes interest for the funds lent.
It can be seen from the definition above that there are two legs to the same transaction in
a repo/ reverse repo. The duration between the two legs is called the
„repo period‟. Predominantly, repos are undertaken for one day period. Settlement of repo
transactions happens along with the outright trades in government securities.
The money market is regulated by the Reserve Bank of India. All the above mentioned
money market transactions should be reported on the electronic platform called the
Negotiated Dealing System (NDS).
K.E.S. SHROFF COLLEGE Page 41
Collateralized Borrowing and Lending Obligation (CBLO)
CBLO is another money market instrument operated by the Clearing Corporation of
India Ltd. (CCIL), for the benefit of the entities who have either no access to the
interbank call money market or have restricted access in terms of ceiling on call
borrowing and lending transactions. CBLO i s a di scount ed i nst rum ent
available in electronic book entry form for the maturity period ranging from one day to
ninety days (up to one year as per RBI guidelines). In order to enable the market
participants to borrow and lend funds, CCIL provides the Dealing System through
Indian Financial Network (INFINET), a closed user group to the Members of the
Negotiated Dealing System (NDS) who maintain Current account with RBI and through
Internet for other entities who do not maintain Current account with RBI
By participating in CBLO market, CCIL members can borrow or lend funds against the
collateral of eligible securities. Eligible securities are Central Government securities
including Treasury Bills, and such other securities as specified by CCIL from time
to time. Borrowers in CBLO have to deposit the required amount of eligible securities
with the CCIL based on which CCIL fixes the borrowing limits. CCIL matches the
borrowing and lending orders submitted by the members and notifies them. While the
securities held as collateral are in custody of the CCIL, the beneficial interest of the
lender on the securities is recognized through proper documentation.
Commercial Papers (CPs)
Commercial Paper (CP) is an unsecured money market instrument issued in the form of a
promissory note. Corporate, primary dealers (PDs) and the all-India financial institutions
(FIs) that have been permitted to raise short-term resources under the umbrella limit
fixed by the Reserve Bank of India are eligible to issue CP. CP can be issued for maturities
between a minimum of 7 days and a maximum up to one year from the date of issue.
Certificate of Deposits (CDs)
Certificates of Deposit (CD) is a negotiable money market instrument and issued in
dematerialised form or as a Usance Promissory Note, for funds deposited at a bank
or other eligible financial institution for a specified time period Banks can issue CDs for
maturities from 7 days to one a year whereas eligible FIs can issue for maturities 1 year to
K.E.S. SHROFF COLLEGE Page 42
Role of FIMMDA:
The Fixed Income Money Market and Derivatives Association of India (FIMMDA),
an association of Commercial Banks, Financial Institutions and Primary Dealers, was
incorporated as a Company under section 25 of the Companies Act,1956. FIMMDA is a
voluntary market body for the bond, money and derivatives markets. It represents market
participants and aids the development of the bond, money and derivatives markets. It acts as
an interface with the regulators on various issues that impact the functioning of
these markets. It also undertakes developmental activities, such as,
introduction of benchmark rates and new derivatives instruments, etc. FIMMDA
releases rates of various Government securities that are used by market
participants for valuation purposes. FIMMDA also plays a constructive role in the
evolution of best market practices by its members so that the market as a whole
operates transparently as well asEfficiently.
K.E.S. SHROFF COLLEGE Page 43
RISKS INVOLVED IN HOLDING GOVERNMENT
SECURITIES AND TECHNIQUES FOR MITIGATING SUCH
Government securities are generally referred to as risk free instruments, in view of
The fact that sovereigns are not expected to default on their payments. However, as is the
case with any financial instrument, 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. The following are the major risks associated with
holding Government securities.
Market risk – Market risk arises out of adverse movement of prices of the securities
that are held by an investor due to change in interest rates. This will result in booking
losses on marking to market or realizing a loss if the securities are sold at the adverse
prices. Small investors, to some extent, can mitigate market risk by holding the bonds
till maturity so that they can realize the yield at which the securities were actually bought.
Reinvestment risk – 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.
Liquidity risk – Liquidity risk refers to the inability of an investor to liquidate (sell) his
holdings due to non availability of buyers for the security, i.e., no trading activity in that
particular security. Usually, when a liquid bond of fixed maturity is bought, its tenor gets
reduced due to time decay. For example, a 10 year security will become 8 year security
after 2 years due to which it may become illiquid. Due to illiquidity, the investor may need
to sell at adverse prices in case of urgent funds requirement. However, in such cases,
eligible investors can participate in market repo and borrow the money against the
collateral of the securities.
K.E.S. SHROFF COLLEGE Page 44
Holding securities till maturity could be a strategy through which one could avoid
market risk. Rebalancing the portfolio wherein the securities once they become short
term are sold 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. Market risk and reinvestment
risk could also be managed through Asset Liability Management (ALM) by matching the
cash flows with liabilities. ALM could also be undertaken by matching the duration of the
Advanced risk management techniques involve use of derivatives like Interest Rate
Swaps (IRS) through which the nature of cash flows could be altered. However,
these are complex instruments requiring advanced level of expertise for proper
understanding. Adequate caution, therefore, need to be observed for
undertakingthe derivatives transactions and such transactions should be undertaken only
after having complete understanding of the associated risks and complexities.
K.E.S. SHROFF COLLEGE Page 45
IMPORTANT INFORMATION FOR INVESTOR
A How are the dealing transactions recorded by the dealing desk?
For every transaction entered into by the trading desk, a deal slip should be generated
whichshould contain data relating to nature of the deal, name of the counter-party, whether
it is a direct deal or through a broker (if it is through a broker, name of the broker),
details of security, amount, price, contract date and time and settlement date. The deal slips
should be serially numbered and verified separately to ensure that each deal slip has been
properly accounted for. Once the deal is concluded, the deal slip should be immediately
passed on to the back office (it should be separate and distinct from the front office)
for recording and processing. For each deal, there must be a system of issue of
confirmation to the counter-party. The timely receipt of requisite written confirmation
from the counter-
party, which must include all essential details of the contract, should be monitored by the
back office. With respect to transactions matched on the NDS-OM module, the need for
counterparty confirmation of deals matched on NDS-OM will not arise as NDS-OM is
an automated order matching system wherein trades are automatically executed on
matching buy/sell orders. However, in case of trades finalized in the OTC market and
reported on NDS, confirmations have to be submitted by the counterparties in the
system i.e., NDS. Also, please see Question
Once a deal has been concluded through a broker, there should not be any substitution
of the counter-party by the broker. Similarly, the security sold / purchased in a
deal should not be substituted by another security under any circumstances. A maker-
checker framework should be implemented to prevent any individual misdemeanour. It
should be ensured that the same person is not carrying out the functions of maker (one
who inputs the data) and checker (one who verifies and authorizes the data) on the system.
K.E.S. SHROFF COLLEGE Page 46
B . What a r e t h e i mp o r t a n t c o n s i d e r a t i o n s w h i l e u n d e r t a k i n g
s e c u r i t y transactions?
The following steps should be followed in purchase of a security:
i) Identify which security to invest in – Typically this involves deciding on
the maturity and coupon. Maturity is important because this determines the
extent of risk an investor like an UCB is exposed to – higher the maturity, higher
the interest rate risk or market risk. If the investment is largely to meet statutory
requirements, it may be advisable to avoid taking undue market risk and buy
securities with shorter maturity. Within the shorter maturity range (say 5-10
years) it would be safer to buy securities which are liquid, that is, securities
which trade in relatively larger volumes in the market. The information about
such securities can be obtained from the website of the CCIL
(http://www.ccilindia.com/OMMWCG.aspx), which gives real-time secondary
market trade data on both NDS and NDS-OM. Since pricing is more transparent
in liquid securities, prices for these securities are easily obtainable thereby reducing
the chances of being misled/misinformed on the price in these cases. The coupon
rate of the security is equally important for the investor as it affects the total
return from the security. In order to determine which security to buy, the investor
must look at the Yield to Maturity (YTM) of a security (please refer to Box III
under para 19.4 for a detailed discussion on YTM). Thus, once the maturity and
yield (YTM) is decided, the UCB may select a security by looking at the
price/yield information of securities traded on NDS-OM or by negotiating with
bank or PD or broker.
ii) Where and Whom to buy from- In terms of transparent pricing, the NDS-OM is the
safest because it is a live and anonymous platform where the trades are
disseminated as they are struck and where counterparties to the trades are not
revealed. In case the trades are conducted on the telephone market, it would be safe
to trade directly with a bank or a PD. In case one uses a broker, care must be
exercised to ensure that the broker is registered on NSE or BSE or OTC
Exchange of India. Normally, the active debt market brokers may not be
interested in deal sizes which are smaller than the market lot (usually Rs.5
crore). So it is better to deal directly with bank / PD or on NDS-OM, which also
has a screen for odd-lots. Wherever a broker is used, the settlement should not
happen through the broker. Trades should not be directly executed with any
counterparties other than a bank, PD or a financial institution, to minimize the risk
of getting adverse prices.
iii) How to ensure correct pricing – Since investors like UCBs have very small
requirements, they may get a quote/price, which is worse than the price for
standard market lots. To be sure of prices, only liquid securities may be chosen
for purchase. A safer alternative for investors with small
requirements is to buy under the primary auctions conducted by RBI
through the non-competitive route. Since there are bond auctions about twice
every month, purchases can be considered to coincide with the auctions.
Please see question 12 for details on ascertaining the prices of the Government
K.E.S. SHROFF COLLEGE Page 47
C Why does the price of Government security change?
The price of a Government security, like other financial instruments, keeps
fluctuating in the secondary market. The price is determined by demand and supply of
the securities. Specifically, the prices of Government securities are influenced by the
level and changes in interest rates in the economy and other macro-economic factors, such
as, expected rate of inflation, liquidity in the market, etc. Developments in other markets
like money, foreign exchange, credit and capital markets also affect the price of the
government securities. Further, developments in international bond markets, specifically
the US Treasuries affect prices of Government securities in India. Policy actions by
RBI (e.g. announcements regarding changes in policy interest rates like Repo Rate,
Cash Reserve Ratio, Open Market Operations etc.) Can also affect the prices of
K.E.S. SHROFF COLLEGE Page 48
D. How does one ascertain the price of a Government security?
The return on a security is a combination of two elements (i) coupon income – that is,
interest earned on the security and (ii) the gain / loss on the security due to price
changes and reinvestment gains or losses.
Price information is vital to any investor intending to either buy or sell
Government securities. Information on traded prices of securities is available on
the RBI website http://www.rbi.org.in under the path Home → Financial
Markets Watch → Government securities market → NDS. This will
show a table containing the details of the latest trades undertaken in the market
along with the prices. Additionally, t r a d e i n f o r m a t i o n can a l s o b e s e e n
o n C C I L w e b s i t e http://www.ccilindia.com/OMHome.aspx. This page can also
be accessed from the RBI website through the link provided. In this page, the list
of securities and the summary of trades is displayed. The total traded amount
(TTA) on that day is shown against each security. Typically liquid securities are
those with the largest amount of TTA. Pricing in these securities is efficient and
hence UCBs can choose these securities for their transactions. Since the prices are
available on the screen they can invest in these securities at the current prices
through their custodians. Participants can thus get real-time information on traded
prices and make informed decision while buying / selling government
securities.The screenshots of the
Above website pages are given below:
K.E.S. SHROFF COLLEGE Page 49
The website of the Fixed Income, Money Market and Derivatives Association
(FIMMDA), (www.fimmda.org) is also a source of price information especially on
securities that are not traded frequently
E. What is the relationship between Yield and Price of a bond?
If interest rates or market yields 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. The relationship between yield
to maturity and coupon rate may be stated as follows:
• When the market price of the bond is less than the face value, i.e., the bond
sells at a discount, YTM > current yield > coupon yield.
• When the market price of the bond is more than its face value, i.e., the bond
sells at a premium, coupon yield > current yield > YTM.
• When the market price of the bond is equal to its face value, i.e., the bond sells
at par, YTM = current yield = coupon yield.
F. How is the yield of a bond calculated?
An investor who purchases a bond can expect to receive a return from one or more
of the following sources:
• The coupon interest payments made by the issuer;
• Any capital gain (or capital loss) when the bond matures or it is sold; and
• Income from reinvestment of the coupon interest payments or interest-on-
The three yield measures commonly used by investors to measure the potential
return from investing in a bond are briefly described below:
K.E.S. SHROFF COLLEGE Page 50
19.2 The coupon yield is simply the coupon payment as a percentage of the face
value. Coupon yield refers to nominal interest payable on a fixed income security
like Government security. This is the fixed return the Government (i.e., the issuer)
commits to pay to the investor. Coupon yield thus does not reflect the impact of
interest rate movement and inflation on the nominal interest that government pays.
Coupon Interest / Face Value
Market Value: Rs.103.00
Coupon yield = 8.24/100 = 8.24%
19.3 The current yield is simply the coupon payment as a percentage of the bond‟s
purchase price; in other words, it is the return a holder of the bond gets against its
purchase price which may be more or less than the face value or the par value.
The current yield does not take into account the reinvestment of the interest
income received periodically.
Current yield = (Annual coupon rate / purchase
The current yield for a 10 year 8.24% coupon bond selling for Rs.103.00 per
Rs.100 par value is calculated below:
Annual coupon interest = 8.24% x Rs.100 = Rs.8.24
Current yield = (8.24/Rs.103)*100 = 8.00%
The current yield considers only the coupon interest and ignores other sources of
return that will affect an investor‟s return.
19.4 Yield to Maturity (YTM) is the expected rate of return on a bond if it is held
until its maturity. The price of a bond is simply the sum of the present values of all
its remaining cash flows. Present value is calculated by discounting each cash flow at
a rate; this rate is the YTM. Thus YTM is the discount rate which equates the
present value of the cash flows from a bond to its current market price. In other
words, it is the internal rate of return on the bond. The calculation of YTM
involves a trial-and-error procedure. A calculator or software can be used to obtain a
bond‟s yield-to-maturity easily.
K.E.S. SHROFF COLLEGE Page 51
The Market in Government Securities is significant part of the Stock market in
India. The marketable debt issued by Government and Semi-Government bodies
which represents a claim on the Government is called Government Securities. A
market where the Government Securities are bought and sold is called Government
Securities market. The securities of Central and State Government are issued in the
form of Stock Certificates, promissory notes and Bearer bonds. A Treasury bill is a
particular kind of finance bill or a promissory note put out by the Government of the
country, Auctioning is a method of trading whereby merchants bid against one
another and where the securities are sold to the highest bidder. Government Securities
are unique and important financial instruments in the financial market.
The size of annual floatation‟s of securities has gone up from 75 crores in
1960-61 to Rs. 7015 crores in 1988-89 in case of Central Government Securities and
from Rs. 67 crores to Rs. 2074 crores in case of State Government Securities in the
same period. The preparation of Government Securities in the same period. The
preparation of Government Securities owned by the RBI has gone down, In order to
encourage wider participation of all classes of investors across the country in
Government Securities, the government, RBI and SEBI have introduced trading in
Government Securities through a nation-wide, anonymous, order-driven screen based
trading system of Stock Exchanges. The participants in Government Securities are
Central and State Government, banking sector Insurance, Companies, Provident funds
and Special financial institutions. Joint Stock Companies, Local authorities, Trust and
individuals as well as non-residents also participate in this market. The face value of
the Government Securities is Rs. 100 or Rs. 1000 and there is a practice of issuing
these Securities at a discount. The gross redemption and running yields in
Government Securities have been increasing and it is in the range of 8 to 10%. The
management of gilt-edged market has a considerable bearing on the advances and
liquidity of commercial bank so as to help the monetary policy. The RBI has
undertaken various reforms in the Government Securities market in India.
K.E.S. SHROFF COLLEGE Page 52
SR.NO NAME OF THE SOURCE AUTHOR
1 FINANCIAL MARKETS Dr. P.K.
2 SECURITIES MARKETS AND
3 INVESTMENT AND SECURITIES
MARKETS IN INDIA