A government bond is a bond issued by a national government denominated in the country's owncurrency.

Bonds issued by national governments in foreign currencies are normally referred to assovereign bonds.
The first ever government bond was issued by the English government in 1693 to raise money to fund a war
against France. It was in the form of a tontine.
Risk-Government bonds are usually referred to as risk-free bonds, because the government can raise taxes
to redeem the bond at maturity. Some counter examples do exist where a government hasdefaulted on its
domestic currency debt, such as Russia in 1998 (the "ruble crisis"), though this is very rare. As an example,
in the US, Treasury securities are denominated in US dollars. In this instance, the term "risk-free" means
free of credit risk. However, other risks still exist, such as currency risk for foreign investors (for example
non-US investors of US Treasury securities would have received lower returns in 2004 because the value of
the US dollar declined against most other currencies). Secondly, there is inflation risk, in that the principal
repaid at maturity will have less purchasing power than anticipated if the inflation outturn is higher than
expected. Many governments issue inflation-indexed bonds, which should protect investors against inflation
risk

Governments issue bonds to raise money for spending on infrastructure projects or for their day-to-day
expenditure. Likewise, companies also raise money through bonds to meet their capital expenditure or
working capital needs.

In the Indian Securities Market, the term ‘bonds’ is generally used for debt instruments issued by the
Central and State Governments and public sectororganizations; and the term ‘debentures’ is used for debt
instruments issued by the private corporate sector. However, the terms bonds, debentures, and debt
instruments are used by the general public inter-changeably.

WHY DO GOVERNMENTS RAISE MONEY

Governments issue bonds to fund their day-to-day operations or to finance specific projects. When investors
buy a bond, they are loaning their money for a certain period of time to the issuer; usually at a fixed rate of
interest. In return, bond holders get back the loan amount at maturity; plus interest payments at periodical
intervals.

Government of India as well as State Governments raise money through Government Securities (G-Secs).
The income of governments comes in lumpsum amounts whereas the expenditure is steady as a result there
will be a gap between revenue and expenditure. For example, income tax is paid at quarterly intervals by
corporates whereas governments incur expenses, like, salaries, etc., on a monthly basis.

To bridge the gap, governments raise money through G-Secs. There are a few occasions when Governments
receive big money through disinvestment of state-owned enterprises or in a specific situation like auction of
3G spectrum to telecom companies through which GOI expects to raise over Rs 25,000 crore. Over a period
of several decades, the governments’ deficit has gone up substantially. As on September 29,, 2009, the
outstanding stock of Government of India securities is at Rs 17.42 lakh crore, which means this much
amount is owed by the Government of India to bondholders as on September 29, 2009. This is excluding
the outstanding amount of Treasury Bills (TBills are raised for short term maturity of 364 days or less) at
Rs 2.17 lakh crore as on September 25, 2009.

1
HOLDING OF GOVT. SECURITIES BY BANKS

The statutory liquidity ratio (SLR) for banks has been reduced to the present 24 percent from a high of
38.5%; while banks’ SLR now is around 33 per cent, signifying that they are holding government securities
far in excess over and above the SLR requirements, estimated excess being to the tune of Rs 4.00 lakh crore
(including Banks’ temporary parking of funds in RBI’s Liquidity Adjustment Facillity-Reverse Repo) as at
the end of September 2009. Banks hold government securities not only on account of statutory prescriptions
and lowest risk weight for capital adequacy purposes but also as profitable investment. However as credit
demand picks up and credit portfolios of banks expand aided with better credit culture and risk management
practices, banks' resource allocation to support government borrowings may progressively get impacted.

CRITERIA FOR PICKING UP BONDS FOR A PORTFOLIO

Liquidity: In the market, some bonds of certain maturity are tradeable easily due to high
volume of transactions; whereas, some bonds offer little or no liquidity due to lack of interest on the part of
investors. As such, while choosing to have a portfolio of bonds, it is better to look for liquidity of the
particular bond in the market place.

Return from the bond: Another important criterion for the investor before investing in bonds is the return it
offers. Most bonds offer periodic interest payments, either half yearly or yearly, to investors.

Credit default: While Government bonds carry sovereign guarantee and as such their credit default risk is
zero, some corporate bonds entail some degree of credit default. As such, investors need to know the credit
rating of the bonds rated by a reputed rating agency. Many financial institutions have their own credit rating
models to assess the risk of credit default using parametres, like, debt-equity ratio, interest coverage ratio,
cash flows, outlook on industry, return on equity and a few qualitative factors.

Taxability of bonds: Governments often come out with tax-free bonds which means the interest income
received from the issuer is free from income tax in the hands of the investors. Last month, Government of
India has announced an issue of Rs 40,000-crore infrastructure bonds by India Infrastructure Finance
Company Limited (IIFCL) as part of two Economic Stimulus Packages announced in December 2008 &
January 2009.

Investment horizon: Different investors have different needs and expectations from their investments. One
important factor for investors is the time they want to stay invested. According to the time horizons,
investors zero in on certain investments to meet their time horizon and requirements.