What are G-Sec yields, and how and why do they go up and down?
What is Government Securities?
- G-secs, or government securities or government bonds, are instruments that governments use to borrow money. Governments routinely keep running into deficits — that is, they spend more than they earn via taxes. That is why they need to borrow from the people.
- In any economy, there is often a mismatch of financial resources. Often, those who have surplus funds do not know what to do with it, while there are many who know what to do with the money but do not have any funds to spare.
- This mismatch creates the reason why some people lend and others borrow. For instance, a lot of households and individuals save money while most businesses and governments borrow money.
How do G-sec yields go up and down?
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- Imagine a scenario in which the government floats just one G-sec, and two people want to buy it. Competitive bidding will ensue, and the price of the bond may rise from Rs 100 (its face value) to Rs 105. Now imagine another lender in the picture, which pushes the price further up to Rs 110.
- The main relation is coupon rate is inversely proportional to the G-sec market price.
- But here is the crucial thing: the coupon payment on the G-sec is still Rs 5.
- So, if you bought the bond at Rs 100, then the yield is 5% but if the price of the bond goes up to Rs 105 then the yield will fall; it will become 4.76% because the second person will be getting Rs 5 over an investment of Rs 105.
- Further, if bidding leads to the price going to Rs 110, then the third person (who finally bought the bond at Rs 110) will find that the yield has fallen further to 4.54%; because the third person would have invested Rs 110 for the same return of Rs 5.
What do G-sec yields show?
- As mentioned earlier, G-secs are the safest investments in any economy, and the G-sec yield is the lowest risk-free interest rate in any economy.
- As such, they are a good way to figure out the broader trend of interest rates in the economy.
- If G-sec yields (say for a 10-year bond) are going up, it would imply that lenders are demanding even more from private sector firms or individuals; that’s because anyone else is riskier when compared to the government.
- It is also known that when it comes to lending, interest rates rise with the rise in risk profile. As such, if G-sec yields start going up, it means lending to the government is becoming riskier.
- If you read that the G-sec yields are going up, it suggests that the bond prices are falling. But the prices are falling because fewer people want to lend to the government. And that in turn happens when people are worried about the government’s finances (or its ability to pay back).
- The government’s finances may be in trouble because the economy is faltering and it is unlikely that the government will meet its expenses.
- By the reverse logic, if a government’s finances are sorted, more and more people want to lend money to such a G-sec. This in turn, leads to bond prices going up and yields coming down.
Reference
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