What are G-Sec yields, and how and why do they go up and down?

What are G-Sec yields, and how and why do they go up and down?

 Subject: Economy

Section: Money Market

The government said that it had decided to keep interest rates on small savings instruments unchanged for the July-September quarter, defying expectations of a hike in rates given the sharp rise in government security (G-sec) yields over the last three months.

Government bonds and bond yield:

• G-secs, or government securities or government bonds, are instruments that governments use to borrow money.
• Safest of all-the chances of the government not paying back your money are almost zero. It is thus the safest investment one can make.
• Constant fluctuating yield–
  • 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.
  • Suppose the government floats a 10-year G-sec with a face value of Rs 100 and a coupon payment of Rs 5-it would mean that one will give Rs 100 to the government today and the government will promises to
    • return the sum of Rs 100 at the end of tenure (10 years), and
    • pay Rs 5 each year until the end of this tenure.
  • However, these bonds are further traded in the secondary market-Imagine two people want to buy it, given the competitive bidding- the price of the bond may rise from Rs 100 to Rs 105. If demand for bonds further rises, the price further rises to Rs 110, the coupon payment on the G-sec remaining at Rs 5.
  • So, 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.

What do G-sec yields show?

• 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.
• The G-sec yields rising 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 ability to pay back .
• 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.