Government securities

If you want to invest in financial instruments with relatively low risk, government securities might be your choice. You may come across initialisms such as BOT, BTP, and CCTeu, as well as technical terms like coupons, issuance, primary market, or secondary market. It might seem complicated, but some basic knowledge will help you navigate the various types of government securities and choose the ones that best suit your needs.

What are government securities?

Government securities are bonds issued by a government. Like all bonds, they represent a loan: in this case, the government is the borrower, and the investor (who purchases the bond) is the lender.

Why does the government issue these bonds? To finance the public deficit (the excess of spending over revenues) and to repay maturing bonds. Government bonds have very different characteristics depending on:

• the maturity;
• whether or not there are periodic payments (coupons);
• the type of interest rate (fixed or variable).

The interest rates on government bonds often serve as a basis for calculating the cost of financing and comparing the returns of other investments.

Buying government securities

You can buy government bonds either at auction when they are issued, i.e., in the primary market, or on the secondary market, where they are traded daily. In both cases, you must contact your bank or an authorized financial intermediary. The auction calendar is available on the Ministry of Economy and Finance website. You can book bonds at least one day before the auction date.

Types of government securities

There are various types of government securities. Some of the most well-known include:

• Treasury Bills (BOTs): these are short-term bonds (3, 6, or 12 months). They don't pay periodic coupons but offer repayment of a predetermined amount (the face value ) at maturity. The return is given by the difference between the face value and the subscription price, known as the 'discount at issuance', or between the face value and the trade price, known as the 'trade premium'. For example, if you buy a BOT for €97 with a face value of €100, the discount at issuance is €3;
• 'Traditional' Treasury Bonds (BTPs): these are medium-to-long-term bonds (ranging from 2 months to 50 years) with a fixed interest rate. Every six months, you are entitled to receive coupons of the same amount, as each coupon is calculated as a fixed percentage of the face value. At maturity, you are entitled to the repayment of the face value. For example, if you purchase a BTP with a face value of €100 and a coupon rate of 4 per cent, you will receive €4 annually in two semiannual installments (i.e., €2 every six months), and at maturity, you will be repaid €100 regardless of the price you paid for the bond.
  On the market, there are other types of BTPs that, unlike traditional ones, may have variable payments (indexed coupons) based on certain parameters or indicators. You can recognize these by their names, which include additional words or acronyms compared to the regular BTP designation. For example, BTP€i and BTP Italia offer variable payments based on the inflation rate of the Euro area and Italy, respectively.

• Certificati di Credito del Tesoro Indicizzati all'Euribor (CCTeu): these are medium-term bonds (with maturities between 3 and 7 years). They pay semiannual coupons that vary based on a market interest rate (6-month Euribor) plus a margin called a spread.

Costs and taxes on government securities

When considering investing in government bonds, remember that you'll need to pay not only the purchase price but also any commissions to the bank or authorized financial intermediary that facilitates the purchase for you. One example of this is the buy-sell commissions. In some cases, the bank or financial intermediary is required by law to adhere to certain limits on these commissions.

Keep in mind, also, that the return on Italian government bonds and those from countries on the 'white list' (which includes the EU and other compliant nations) is subject to a more favorable tax rate of 12.5 per cent, compared to the usual 26 per cent for other financial instruments.

Risks to watch out for

Like any investment, investing in government bonds involves risks that are typical of bonds, including interest rate risk (i.e., the bond's price may fall due to rising market rates) and credit risk (i.e., the issuer may fail to pay coupons or redeem the principal).

In general, the credit risk for government bonds is lower than for bonds issued by private entities in the same country. In many developed countries, the credit risk for short-term bonds is so low that they can be considered 'risk-free'.

Other things being equal, interest rate risk primarily affects fixed-rate bonds and increases the farther the bond's maturity is. There is an inverse relationship between the price of a fixed-rate bond and changes in market interest rates: as rates rise, the bond's price falls, and vice versa. Credit risk typically increases with the bond's maturity as well.

BOTs, which always have a maturity of one year or less, are among the least risky financial instruments. The next level of risk is associated with variable-rate government bonds (like CCTeu and inflation-indexed BTPs), followed by traditional BTPs, which, under similar conditions (like maturity), are the riskiest among government bonds and, therefore, the most rewarding.