Government securities

What they are

Government securities are bonds (see 'bonds' facts sheets) issued by governments to finance their country and its institutional activities. This is why they are also called 'sovereign bonds'. In Italy they are issued by the Ministry of Economy and Finance, through the Treasury. In other words, they represent a loan to the State by their subscribers.

Government securities can either be purchased at auction, i.e. at the time of issue (on the primary market), or on the secondary market, where they are traded daily. In both cases, in order to buy them you need to contact your own bank or an authorized financial intermediary. The annual calendar of Government securities auctions is published on the website of the Ministry of Economy and Finance.

Securities can be reserved at least one day before the date set for the auction.

A decree by the Ministry of Economy and Finance sets out in ten articles the rules on transparency in the public placement of government securities. Banks and financial intermediaries must apply this 'decalog' in their dealings with customers who buy government securities. It is right that investors be aware of the decalog's existence in order to know if their intermediary is behaving properly. Click here for more details.

Depending on their yields, government securities can be divided into:

  • fixed-yield securities, for which the coupons at maturity and the redemption price are both fixed. Returns can come from:
    • the 'issue premium', i.e. the difference between the subscription price (issued at 'below par' or at below face value) and the price reimbursed at maturity (face value);
    • the collection of a fixed or periodic interest rate (known as a 'coupon');
  • variable-yield securities, the coupon and/or redemption value are calculated on a certain date based on an external parameter. The parameter and calculation method, which the potential subscriber is aware of, determine the indexation of the security. This can be:
    • financial, linked, for example, to the Euribor rate;
    • currency-related, linked to a given exchange rate at a given time;
    • real, linked to a rate of inflation in a certain area (for example Italy or the Eurozone); thereby guaranteeing protection against an increase in the price levels.

The characteristics of different Government securities are described on the MEF's website

Interested parties

Governments, because Government bonds are a source of financing for countries and favour public investment.

Small savers, because they can put their savings into a relatively safe instrument, which:

  • carries a very low risk (see 'Strengths and drawbacks');
  • can guarantee a certain income and, if linked to indexation parameters, also permits forms of protection (such as purchasing power through the link to the inflation rate);

is easily liquidated, enabling savers to cope with unexpected and urgent cash flow requirements.

Strengths and drawbacks

Government securities are easily liquidated thanks to the high volumes issued and the large number of requests for their purchase and sale. They therefore have the advantage of being easily resold, before they mature and at the conditions prevailing at that time on the regulated markets, enabling them to cope with unexpected and urgent cash flow requirements.

Since they are a form of credit extended by subscribers to the State, the greatest risk is linked to a situation of insolvency, on the part of the issuing State, in interest payments or the repayment of the principal (this is called 'country risk'). One index that is often consulted when assessing investments is the rating, a synthetic judgment on the issuer's solvency assigned by independent specialist agencies.

The risk of inflation (for securities with longer maturities) and exchange rate risk (for securities denominated in foreign currencies) could have negative effects on the investment's return.

Expenses

The costs linked to investment in Government bonds at auction are the fees owed to the intermediaries for their safekeeping (it becomes necessary to open a 'securities account'). For BOTs only, placement fees are envisaged, which can vary based on the nominal amount subscribed and on the duration of the security.

By contrast, secondary market purchases entail a fee (higher than the one paid at auction) payable to the intermediary that conducts the operation.

Any form of income from Government bonds is subject to tax.

Underlying rules

Subscribers of this investment instrument have a credit claim in respect of the issuing State relative to periodic coupons and the redemption of the principal at maturity.

All the characteristics of the security are clearly spelled out to potential investors through their publication on the MEF's website. Moreover, the regulated markets in which these instruments are listed guarantee high levels of transparency and certainty of execution of the transactions.

Pitfalls

Investing wisely means paying attention to your financial needs and is best undertaken as part of your broader financial planning. Securities with very lengthy maturities can offer higher returns but are potentially subject to fluctuations in prices and to inflation developments, which could affect the real value of the coupons and, above all, the principal at maturity.

The close correlation between risk and returns must also be taken into consideration. The reason for the interest rate differential between different Government securities issuers (often indicated by the word 'spread') is essentially linked to the 'country risk': the greater this risk, the higher the interest rate that the State will have to pay on its securities.

Keywords

YIELD

The fruit of an investment measured in relation to the capital employed and generally expressed as a percentage ('rate of return').