Gilts 101?

ChilliBob

Guys, I'm trying to find some decent grounding in gilts to help the decision on whether to buy any or not, but I'm struggling really!

Thus far I seem to have the following in my head (I know there are gaps!)

* You can purchase different maturity gilts. One *could* view this a bit like a fixed savings account, however, you can also sell *before* maturity - which may or may not work out beneficial! 

* If you hold till maturity you know with 100% certainly what you will get back - £10k of 5 Yr gilts gets you £10k in 5 years, plus whatever your coupon is. Assuming the UK government doesn't default!

* The coupon is taxable in the same way bank account interest is, if unsheltered.

* A capital gain is tax free... However, surely this means selling before maturity, if holding till maturity then surely there is no gain.

* If holding a gilt to maturity, and assuming the UK government doesn't default, then this can be directly compared to a fixed term savings account? - so, if you had a gilt paying 4.7% for 2 years and a fixed saver the paying the same... Ignoring transaction costs the gilt is actually the more flexible option since you can sell before maturity. 

So yeah, I feel I have some major gaps in my gilt 101 knowledge, but I'm struggling to find out what really, any links, guides, comments much appreciated! 

mr._prude

My understanding is with bonds/gilts when the interest rate goes up, the valve of your coupon will go down.

My long term gilts are down 33%

JohnWinder

Considering nominal, not linkers, gilts having a £100 face value means this is how much the bearer is given when they mature. But the bearer may have bought the bond for more or less than £100; in fact it will be rare that they will have been bought for exactly £100. Imagine a gilt with 1% coupon; every day the interest rates on different bonds change ever so slightly, or a lot more, as people buy and sell them. As a consequence, and because the coupon can’t change (it’s part of the contract) then the price of the bond must change if there is to be a difference in ‘interest rates’ from day to day or month to month which there is. Make sense?

ChilliBob

Indeed it does, thanks John. So the certain parts are the maturity value - which may trigger a capital gain, if larger than the purchase cost, (or a loss of the opposite!), and the interest/coupon, which is set.

I'll look at II to get a realistic idea, but it might be something like a gilt for 2.5 years costing £96 with a 4% coupon and a £100 face value...

So, you'd make a gain of £4 when it matures.
You'd make 4% per year on your £96

So, at the point of the purchase, if you hold to maturity, is there any uncertainty?! 

george4064

ChilliBob said:

Indeed it does, thanks John. So the certain parts are the maturity value - which may trigger a capital gain, if larger than the purchase cost, (or a loss of the opposite!), and the interest/coupon, which is set.

I'll look at II to get a realistic idea, but it might be something like a gilt for 2.5 years costing £96 with a 4% coupon and a £100 face value...

So, you'd make a gain of £4 when it matures.
You'd make 4% per year on your £96

So, at the point of the purchase, if you hold to maturity, is there any uncertainty?! 

If you hold the gilt to maturity and the British government doesn’t collapse, there is no uncertainty.

Just remember that if you pay above the nominal value value (I.e. £102 for every £100 nominal amount) you’re guaranteed to lose that £2 above nominal if held to maturity. However coupons received up to that point should make up for it, but it affects the overall return.

GeoffTF

You can find out about gilts here:

https://www.dmo.gov.uk/responsibilities/gilt-market/

You can get prices, redemption yields, accrued interest etc by opening a free account here:

https://reports.tradeweb.com/account/login/

You also need to consider the market spread, which is very unfavourable for retail investors. You only pay half the spread if you hold to maturity. Spreads are smaller if you trade £50+ on the telephone, with the deal being made directly with a market maker.

Linton

ChilliBob said:

Indeed it does, thanks John. So the certain parts are the maturity value - which may trigger a capital gain, if larger than the purchase cost, (or a loss of the opposite!), and the interest/coupon, which is set.

I'll look at II to get a realistic idea, but it might be something like a gilt for 2.5 years costing £96 with a 4% coupon and a £100 face value...

So, you'd make a gain of £4 when it matures.
You'd make 4% per year on your £96

So, at the point of the purchase, if you hold to maturity, is there any uncertainty?! 

Yes, from the point of purchase  if your hold a gilt to maturity the twice-yearly income in £s and the lump sum at maturity are 100% guaranteed barring doomsday events.  If you sell a gilt fund most of the underlying bonds will be some way from maturity so nothing is guaranteed.

Yes again, at maturity you are likely to make a capital gain or loss.  You are not charged CGT on gilt sales.

One other point I will add.  Some comments, even mine, have referred to old and new bonds as if there is a benefit from disposing of the former to buy the latter.  In fact this is misleading as the very reason why bonds issued prior to the recent rises in terest rates have fallen in price is the result iof trading which ensures that prices are set so that both old and new bonds provide equivalent total return.  A low interest bond must be cheaper than a high interest bond maturing at the same time to the extent that the extra capital value at maturity compensates for the lower income from the interest.

JohnWinder

Now get your head around the differences between nominal bonds and linkers, and you’re half way there. Then consider whether individual bonds or a fund is better for you.

HappyHarry

So, you'd make a gain of £4 when it matures.
You'd make 4% per year on your £96

1. Yes - you would make a £4 gain on maturity.

2. Not quite - you would receive £4 interest per year, which is 4% of the face value of £100 and not 4% of the £96 paid in this example.

ChilliBob

HappyHarry said:

So, you'd make a gain of £4 when it matures.
You'd make 4% per year on your £96

1. Yes - you would make a £4 gain on maturity.

2. Not quite - you would receive £4 interest per year, which is 4% of the face value of £100 and not 4% of the £96 paid in this example.

Thanks, I did wonder if it was based on the market price or the face value. 

ChilliBob

GeoffTF said:

You can find out about gilts here:

https://www.dmo.gov.uk/responsibilities/gilt-market/

You can get prices, redemption yields, accrued interest etc by opening a free account here:

https://reports.tradeweb.com/account/login/

You also need to consider the market spread, which is very unfavourable for retail investors. You only pay half the spread if you hold to maturity. Spreads are smaller if you trade £50+ on the telephone, with the deal being made directly with a market maker.

This point confuses me a bit, why is the spread relevant if you're just buying to hold till maturity? Sorry, that may be a very naive question!

Now I need to look on II to see what's on offer, prices etc to get my head around the actual options. I looked at the 'public'  II site last night and was quite confused! 

In my circumstances I'm comparing these gilts to their alternate, for me, a fixed savings account.