Government securities offer one of the most secure and lucrative investment options to investors, whether corporates or individuals. They are available for varying maturity periods, ranging from 1-20 years at present, and an investor can purchase these securities for as little as Rs 25,000. What an investor should ideally do is first decide the amount for which he wishes to purchase the securities and the number of years for which he plans to invest in them. Once the investor has resolved these two main issues, he should contact a primary dealer (PD), such as PNB Gilts Ltd, and indicate his requirement for the amount and tenure. The PD will then inform the customer about the various government securities available that match his requirement.

A number of government securities are issued every year, besides the ones issued earlier; therefore, an investor does normally have a whole lot of securities from which to choose. For example, an investor wishing to purchase a government security that matures in eight years, i.e. in 2008, can choose from any of the following: the 11.40% GOI 2008, the 12% GOI 2008, and the 12.25% GOI 2008. The month of maturity though might vary depending on the exact day when a particular security was issued. Government securities are identified by their coupon rates and year of maturity. For example, a 12.25% GOI 2008 indicates that 12.25 per cent is the coupon rate and 2008 the year of maturity, GOI of course denotes the government of India.

Once the seller, i.e. the primary dealer, and the buyer, i.e. the investor, agree on a rate, they decide on a settlement date and conclude the transaction in writing. The written confirmation contains details like the name of the government security, date of transaction and settlement, transaction rate and the total price payable, inclusive of interest.

For any government security being purchased or sold, the settlement amount includes two parts, the principal amount and the interest for the broken period. When a government security is being sold before maturity, the purchaser of a security has to pay the interest for the period that it was held by the seller. This is so because interest on government securities is paid half-yearly by the Reserve Bank of India to the holder on the interest payment date.

Let us understand how the calculation for the settlement amount is done through an example. A client purchases 12.25% GOI 2008 for the face value of Rs 10 lakh at the rate of Rs 105.65. Assuming the settlement is due on October 30, 2000, and the last interest payment date is September 8, the amount that the buyer has to fork out will be calculated as follows: The principle amount payable is Rs 10,56,500 (Rs 10 lakh x 105.65). Added to this is the interest component for 52 days of the broken period (23 days of September, starting September 8, plus 29 days of October until the settlement date of October 30). The interest amount that the customer has to pay in this case will be Rs 17,694.44 (Rs 10 lakh x 12.25 x 52 / 360 x 100).

So, a consolidated sum of Rs 10,74,194 is what the customer will have to pay.The calculations are slightly different in the case of zero coupon bonds, which are comparable to the deep discount bonds issued by financial institutions such as IDBI, ICICI and others. They are issued at a discount to the face value, and no interest is payable on them. The face value is paid on maturity. Take the case of a person who purchases a zero coupon bond of three years' maturity, which gives a return of 10.5% on Rs 25,000. The date of issual of the bond is November 1, 2000, and date of maturity, November 1, 2003. The settlement date for the transaction is November 10, 2000. The total amount to be paid by the investor in this case (bonds with the face value of Rs 25,000) will roughly work out to Rs 19,000.

Once the payment has been made, the primary dealer will transfer the government security from his own demat account to that of the investor. He will receive the half-yearly interest on this security through the depository, just like he receives dividend on shares. Ditto for the maturity proceeds on the redemption date. As for selling of the government securities, a similar procedure has to be followed.

The beauty of dealing in government securities is that if a security is bought for a certain yield, it will remain the same until maturity, even if interest rates fluctuate during its tenure. So you can buy and hold securities and get semi-annual coupons along with the face value on redemption. But that is a passive, albeit totally risk-free, portfolio management strategy, point out experts.

A more active policy is to adopt a buy-and-trade stance so as to maximise returns by exploiting the volatile interest rate regime. For this, it's best to opt for a security with a slightly longer tenure than your requirement.

That is the experts' recipe for riding the yield curve where returns go up with tenure.