SGB pricing in Secondary market

Bonds
1

The LTP for SGBFEB32IV is currently trading around 7912/gram but the current market price of GOLD is ~6894.

So why is it trading at such a high premium?

Also given that it was issued at a face value of 6263 i.e. I am getting Interest on only 6263 instead of CMP, so the SG bond should trade lower than the CMP ( ignoring any accrued interest for the last 6 months)?

In some places, I found that to find the fair value of SGB we need to ADD “All the future interest payments in present value”. Does this mean SGB bought from the secondary market is not entitled to that 2.5% interest artificially as the interest portion is taken by the seller?

@ShubhS9

2

Yeah, all listed SGB prices are trading higher then market price for some months now.
Below are my assumptions for this phenomenon

  1. There has been no new issue of SGB for almost 6 months, so there is lack of supply
  2. Lot of novice investors have started buying listed SGB on periodic basis (every month). I see lot of YT / insta videos telling people how they should be buying 1/2 units of SGB every month for their kids and so on. This people do not really understand the product nor look at prices, and are investing like a SIP, giving sustained demand
  3. I also think lot of Traders are buying up listed SGBs for pledging, and are willing to pay slight premium as returns are tax free and can be sued to pledges.

So I feel lack of supply alongwith sustained demand is raising the price above market prcie.

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3

to find the fair value of SGB we need to ADD “All the future interest payments in present value”. Does this mean SGB bought from the secondary market is not entitled to that 2.5% interest artificially as the interest portion is taken by the seller?

No, it doesn’t mean anything of this sort. The interest is paid out to whoever holds the bond on the interest date.

Read up on the time value of money to understand what the sentence about present value means. In particular, read the sections on present value.

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4

I know that, but to confirm this article is misleading - https://fincues.com/blog/sgb-fair-value

5

the odd thing is the maths checks out if one calculate all the interest we will get and discount it by 6% and add to CMP, that’s the amount these SGBs are trading at.

6

No, the article is not misleading.
Short answer, earlier SGB used to trade at a discount but now most of the scrips are correctly priced.

2 Likes
7

gold is trading at 6894, SGB at 7912 can you explain where is that 1000 coming from and why?

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9

In general the fair value of the bond is the present value of all the future interest payments + the redemption value. (Anything more or less than this would be considered as a premium or discount)

For SGBs although the Gold rates are taken based on the current market rate, it also carries the interest element.

So to determine the fair value of the SGB, all future interest payments also need to be considered.

Like others pointed out, just because the SGBs are trading above their current gold rates, doesn’t mean they are trading at a premium.

They can be considered as trading at a premium only if their current price is more than the ( Gold rate today + present value of future interest payments )

i believe the interest rate used for discounting such future interest payments also needs to be 2.5%.

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so this simply means buying SGB from the secondary market nullified that 2.5% extra one gets, buying from the primary market?

11

Math always works out, especially if you can assume numbers to arrive at it
So if premium decreases, use discounting factor of 8%, and if it reduces use 4% :smiling_face:

If govt is to bring in new issue and introduce supply, lot of this premium will vanish

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12

Yes, the benefits from interest will get nullified if the SGBs are fairly priced.

So in effect, the returns from SGBs would be equivalent to returns from investing in GOLD funds or ETFs, as the return is purely related to appreciation of gold.

The SGBs do offer the benefit of tax exemption upon redemption, but i don’t wanna get into that.

IMO, the best way to invest in SGBs is to invest directly at the time of offer from RBI, as they are issued only w.r.t gold price.

If in the secondary market the SGBs are trading at discount, only then such investment could be advantageous over regular investments such as gold ETFs or mutual funds

13

SGB were issued almost 8 years back. For almost 7 years, most SGB series, were trading at discount or at par to spot gold price.
So was this concept not applicable then? :stuck_out_tongue:

14

:joy:…

I have no clue, am new to the market.

But I get your point.

But my argument would be if SGBs are gonna trade at their spot price of Gold, how is it different from a Gold ETF or MF ?, why would the holder of an SGB be willing to give up the additional interest earning opportunity without charging a price for it ?

In simple terms, a person who has invested in a GOLD ETF would be willing to sell At or above the CMP (spot gold rate)

But a person holding SGBs, can’t be expected to sell at the same CMP, as he needs to consider the interest (opportunity) that he foregoes by selling it early.

So when selling an SGB you would ask for gold spot price + a little extra for this additional interest earning opportunity.

15

In theory you can ask. And you can also ask additional premium because it is tax free return and 10 other things.
It only works if somebody is willing to pay that premium.

Till now no one was willing to pay, as govt was continuously bringing in new supply by fresh issue. Why would someone pay premium if govt is selling at discount to Spot?
And if there is no buyer at that inflated price, it does not matter what sellers thinks is opportunity cost of it.

This is classic demand - supply issue. One can theorize and build justification for this using time value of money, opportunity cost and lot of other concepts.
But if govt brings in fresh supply all this theories will vanish.

Whether govt will bring in new supply or not is doubtful and hence premiums are sustaining.

16

Please don’t consider this as an argument, rather treat is a conversation or exchange of ideas.

I’m sure u might have the experience and expertise on many topics. I am a newbie so I could be wrong.

These are just my views and probably there is a bit of confirmation bias too…

SGB is partly a low yielding bond and partly a gold tracker.

But the government only charges for the gold price at the time of issue, so any new issue is always gonna be attractive.

But should the holder of the SGB too be willing to sell it at the spot rate of gold? probably this would depend on the person and their need for money immediately (emergency).

I totally get the point that demand and supply influences the prices at which any instrument is trading in the market.

Again, theoretically speaking, i wouldn’t call SGBs trading above their spot gold rates as trading at premium, because IMO the holder of SGB is also gonna be eligible for future interest payments, so i would consider it be trading at a premium or discount, only if it is above or below its Fair value.

And obviously this fair value can be subject to contention, as the interest rate used for discounting the future cash flows could vary from person to person based on their yield expectations.

I am not disagreeing, but rather giving an alternate POV for why SGBs don’t necessarily have to trade at their Spot rate and why any price above spot price doesn’t necessarily mean it is trading at a premium, as it is fair for the seller to ask the additional price which corresponds with the PV of interest when selling the SGB.

When there is a need for money ppl would be willing to sell at whatever price they can get due to the emergency, but under normal conditions, if anyone is going to sell, they would want a fair value for their investment and asking for the fair value doesn’t necessarily make it a premium price.

I ask this question again, (Ignoring the tax benefits of SGBs) if the SGBs are gonna trade at the spot price of gold, how is it different from Gold ETFs ?

So there needs to be a difference between the two and this difference is reflected by asking that extra price for the interest opportunity.

17

This is precisely my problem. To somehow justify that this is fair price.
Uninformed investors will buy at this inflated price and feel like they paid the right price.

And if govt comes up with fresh issue at market price, they will be the one complaining that govt looted them. Like they were complaining when govt reduced excise duty on gold and price of SGB crashed.

You can have your views and arguments, but saying that SGB are trading at fair price, and not premium is bit of a stretch in my opinion.
Anyways, I have nothing more to add on this topic :slight_smile:

18

Just to clarify, i never said that whatever price these bonds are trading at today are considered as a fair price.

My point was, there is something called as a fair price and this fair price involves assumption and calculation w.r.t the discount rate used for discounting the future interest payments.

This is similar to that of fundamental analysis, where you discount future estimated cash flows of a company to determine its present worth. Here too the discount rate used is mostly the expected yield.

Same way, in SGB you get a guaranteed fixed coupon which needs to be incorporated into the price to determine the actual fair value of the SGB.

Let’s just agree to disagree if asking for a fair price seems unfair to you.

I just came across this website where they do compare the current price of SGB to their fair value.

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19

Can check this article.

Mainly because of tax advantage, coupon payments and fewer supply.