About Gilts

About gilts

 

A gilt is a UK Government liability denominated in sterling, issued by HM Treasury and listed on the London Stock Exchange. The term “gilt” or “gilt-edged security” is a reference to the primary characteristic of gilts as an investment: their security. This is a reflection of the fact that the British Government has never failed to make interest payments or principal payments on gilts as they fall due. An explanation of terms relating to gilts appears in the glossary.

 

Current types of gilts

 

The gilt market is comprised of two different types of securities - conventional gilts and index-linked gilts. An explanation of the different types of gilt appears below. The DMO publishes a Quarterly Review, which shows the current breakdown of the gilt market by type of gilt as well as how that has evolved over time. A complete list of the gilts currently in issue is available here.

Conventional gilts

Conventional gilts are the simplest form of UK government bond and constitute the largest proportion of the gilts in issue. A conventional gilt is a liability of the government under which it guarantees to pay the holder of the gilt a fixed cash payment (coupon) every six months until the maturity date, at which point the holder receives the final coupon payment and the return of the principal. Payments are rolled forward to the next business day if they fall on a non-business day.
 
The price of a conventional gilt is quoted in terms of price per £100 face value. This face value, otherwise known as the nominal amount, is not necessarily how much the gilt is worth now, or how much it would cost an investor to buy it now; rather, it is the amount of money (or capital repayment) the holder will receive at maturity. Whilst gilt prices are quoted per £100 nominal, gilts can be traded in units as small as a penny.
 
A conventional gilt is denoted by its coupon rate and maturity (e.g. 1½% Treasury Gilt 2047). The coupon rate usually reflects the market interest rate at the time when the gilt is first issued. Consequently, there is a wide range of coupon rates available in the market at any one time, reflecting how interest rates on borrowing have fluctuated in the past. The coupon indicates the cash payment per £100 nominal that the holder will receive per year. This payment is made in two equal semi-annual payments on fixed dates, six months apart.
 
For example, an investor who holds £1,000 nominal of 1½% Treasury Gilt 2047 will receive two coupon payments of £7.50 each on 22 January and 22 July each year until the gilt reaches its final maturity date (in this case 22 July 2047). On the day when the gilt matures, the holder receives the repayment of the principal and the final coupon payment.

 

Index-linked gilts

Index-linked gilts constitute the minority of the gilts in issue. The UK was one of the earliest developed economies to issue index-linked bonds to institutional investors, with the first issue taking place in 1981.

Index-linked gilts differ from conventional gilts in that the semi-annual coupon payments and the principal repayment are adjusted in line with the UK Retail Prices Index (RPI) with a lag. This means that both the coupons and the principal repaid on redemption of these gilts are adjusted to take account of accrued inflation since the gilt was first issued.

As with conventional gilts, an index-linked gilt is denoted by its coupon rate and maturity (e.g. 0⅛% Index-linked Treasury Gilt 2039); and the coupon reflects market interest rates (in real terms) at the time of first issue. As with conventional gilts, payments are rolled forward to the next business day if they fall on a non-business day.

The coupon on an index-linked gilt indicates the cash payment per £100 nominal that will be adjusted for RPI inflation between the first issue date of the gilt and the coupon date, and this amount will be paid to the holder. As with conventional gilts, payment is made in two semi-annual payments on fixed dates, six months apart, but unlike conventional gilts the payments will differ in size depending on the path of inflation between successive coupon dates. On the maturity date of an index-linked gilt, the holder receives the repayment of the principal and the final coupon payment, both adjusted for RPI inflation between the first issue date of the gilt and its maturity date.

The DMO has produced detailed papers including examples which set out the method for calculating cash flows on index-linked gilts. It should be noted that, since the RPI can go down as well as up, cash flows on index-linked gilts (also taking into account the inflation indexation lag) may also fall.

 

Gilt market conventions

Gilt prices

Gilts are actively traded securities and the price of a gilt can change continually whilst the capital markets are trading. The title of a gilt does not tell the investor its price in the market today, nor does it reveal how much the investor would have to pay to buy it or how much they would receive if they sold it (rather than waiting for repayment of the principal at maturity).

Gilt prices change because market pricing changes as views about interest rate prospects and other factors relevant to the capital markets change. A coupon fixed at 3% may look unattractive when market interest rates are at 4%, and it may look generous when market interest rates are at 2%. Prices in the gilt market will adjust to reflect that.

It is not just the comparison with today’s interest rates that matters for gilt prices. The price of a gilt with many years left until it reaches its maturity date reflects the collective assessment of the market about the present value of the flow of coupon payments that will be made over the remaining years until the gilt reaches maturity together with the repayment of principal. That assessment will be affected by many factors, including the market’s collective view of what will happen to interest rates over future years; of both the level of and uncertainty about inflation in the future; and of other issues, such as the levels of outright supply and the strength and nature of demand from investors.

Prices of index-linked gilts, where the coupon payments and capital repayment are protected against changes in inflation, as measured by the RPI, can of course behave differently to those of conventional gilts.

End-of-day reference prices for gilts are produced and administered by FTSE-Tradeweb. They are available without charge to the wider public for non-commercial use from 12.00 noon on the day following initial publication and can be accessed via Tradeweb's website.

 

Gilt yields

The redemption yield, also known as the yield-to-maturity, gives an indication of the actual return on capital that the investor will receive from buying the gilt at the price shown and holding it to maturity.

The yield is different from the coupon. The coupon is fixed for the life of a gilt when it is first issued but the yield will change as gilt prices change. As prices rise the investor is effectively paying more for a series of fixed cash flows and so the yield falls. Conversely, if prices fall the yield rises.

For example, if you paid £100 to buy 3¼% Treasury Gilt 2033 in April 2023 and held it to maturity (redemption), your capital gain/loss would be zero and, therefore, your yield would be the annual coupon earned; i.e. 3.25%. However, if you paid only £90 for this gilt in April 2023 and held it to maturity, you would make a capital gain of £10, in addition to receiving the annual coupon of 3.25%, giving a yield-to-maturity of about 4.53%. Conversely, if you paid £110 for this gilt in April 2023 and held it to maturity, you would make a capital loss of £10, still receiving the annual coupon of 3.25%, giving a yield-to-maturity of about 2.11%. (The redemption yield calculation assumes that the investor reinvests the interest payments received by buying more of the gilt at the same redemption yield).

It follows from this that, to generate the same yield as a higher-coupon gilt, a lower-coupon gilt of similar maturity will be sold at a lower price. For example, for 1% Treasury Gilt 2032 to yield 3.25% in April 2023, it would have to be priced at £82.93.

The DMO has produced detailed papers including examples which set out the method for calculating gilt prices from yields.

 

Gilt transactions

 

When buying or selling gilts, investors need to be aware of two conventions associated with gilts – rules on accrued interest and ex-dividend periods.

 

Accrued interest

When investors are buying or selling a gilt they will generally have to pay or receive an amount of money representing the accrued interest on that gilt. Interest on gilts accrues on a daily basis between one coupon (sometimes also called dividend) date and the next.

For example, 1% Treasury Gilt 2032 pays interest on 31 January and 31 July each year. A purchase of this gilt where the trade settles on 31 August (i.e. a month after the previous coupon payment on 31 July), will include 31 days accrued interest. Assuming the investor does not subsequently sell the gilt, they will receive the full coupon payment (i.e. ½% of the nominal amount held) on the next coupon date (31 January).

The purchase price would, therefore, need to include the interest accrued between the most recent coupon date (31 July) and the settlement date of the transaction (31 August) so as to compensate the seller, who after selling will no longer receive the next coupon on 31 January. This amount is calculated as follows: (1% annual coupon/2 semi-annual payments) x (31 days since the last coupon/184) = £0.084239 per £100 nominal of the gilt. Here, 184 is the number of calendar days between 31 July and 31 January.

Equally the investor will generally receive a corresponding amount of accrued interest if they are selling a gilt.

 

Ex-dividend periods

Coupon payments are payable to the person who is the legally registered holder of a gilt, seven business days before the coupon date, or principal repayment date (at maturity). These periods are known as the ex-dividend periods.

If the investor sells a gilt within an ex-dividend period, they will receive the full dividend payment, but will be required to pay some of money received to the buyer. This payment is known as rebate interest and will be deducted from the proceeds of sales in the contract note.

If the investor is buying a gilt within the ex-dividend period, they are not entitled to the next interest payment and will pay no accrued interest (as detailed above). However, they will be eligible to receive rebate interest for the period between the settlement date of the transaction and the date after the end of the ex-dividend period. The amount of rebate interest will be deducted from the cost of purchase.

If an investor purchases a gilt for settlement on the final day of the ex-dividend period, then they will be entitled to both the final dividend and the principal repayment at redemption of the gilt. Trades cannot settle after the final day within the ex-dividend period.

 

Buying and selling

If a private investor wishes to purchase gilts, the secondary market can be accessed through a stockbroker, bank or the DMO’s Purchase and Sale Service. Only members of the DMO’s Approved Group of Investors can purchase through the DMO’s Purchase and Sale Service.

The Purchase and Sale Service is administered by the HM Treasury appointed registrar, Computershare Investor Services PLC.

Neither Computershare nor the DMO offers investment advice. If you are unsure of what action to take you should always obtain independent financial advice.