Consider the following statements regarding Government security (G-sec) yields. Government securities or government bonds, are instruments that governments use to borrow money. G-sec yields indicates the broader trend of interest rates in the economy. If G-sec yields start going up, it means lending to the government is becoming riskier.Which of the above statements is/are correct?a)1 onlyb)1, 2c)1, 3d)1, 2, 3Correct answer is option 'D'. Can you explain this answer?

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Consider the following statements regarding Government security (G-sec) yields.

Government securities or government bonds, are instruments that governments use to borrow money.
G-sec yields indicates the broader trend of interest rates in the economy.
If G-sec yields start going up, it means lending to the government is becoming riskier.

Which of the above statements is/are correct?

a)
1 only
b)
1, 2
c)
1, 3
d)
1, 2, 3

Correct answer is option 'D'. Can you explain this answer?

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Consider the following statements regarding Government security (G-sec...

G-secs, or government securities or government bonds, are instruments that governments use to borrow money. G-secs carry the lowest risk of all investments.

How are G-sec yields calculated?

G-sec yields change over time; often several times during a single day. This happens because of the manner in which G-secs are structured.
Every G-sec has a face value, a coupon payment and price. The price of the bond may or may not be equal to the face value of the bond.
Here’s an example: Suppose the government floats a 10-year G-sec with a face value of Rs 100 and a coupon payment of Rs 5.
If one were to buy this single G-sec from the government, it would mean that one will give Rs 100 to the government today and the government will promises to 1) return the sum of Rs 100 at the end of tenure (10 years), and 2) pay Rs 5 each year until the end of this tenure.
At this point, the face value of this G-sec is equal to its price, and its yield (or the effective interest rate) is 5%.

How do G-sec yields go up and down?

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.
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?

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.

Answered by Notes Wala · View profile

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Consider the following statements regarding Government security (G-sec) yields. Government securities or government bonds, are instruments that governments use to borrow money. G-sec yields indicates the broader trend of interest rates in the economy. If G-sec yields start going up, it means lending to the government is becoming riskier.Which of the above statements is/are correct?a)1 onlyb)1, 2c)1, 3d)1, 2, 3Correct answer is option 'D'. Can you explain this answer?

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