What are the risks involved in holding Government securities? What are the techniques for mitigating such risks?
Government securities are generally referred to as risk free instruments as sovereigns are not expected to default on their payments. However, as is the case with any fi nancial instrument, there are risks associated with holding the Government securities. Hence, it is important to identify and understand such risks and take appropriate measures for mitigation of the same. The following are the major risks associated with holding Government securities. 29.1 Market risk – Market risk arises out of adverse movement of prices of the securities that are held by an investor due to changes in interest rates. This will result in booking losses on marking to market or realizing a loss if the securities are sold at the adverse prices. Small investors, to some extent, can mitigate market risk by holding the bonds till maturity so that they can realize the yield at which the securities were actually bought. 29.2 Reinvestment risk – Cash fl ows on a Government security includes fi xed coupon every
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