How do Gilts work in practice?

Linton

Ballard said:

wmb194 said:

Ballard said:

I've just looked it up and it's showing a coupon rate of 3% rather than the 6% that has been quoted on this thread and a yield to maturity of -1.243 which doesn't look to be a good choice of investment to me.

You looked at the LSE? It looks like 3% is the next coupon - it pays twice a year - and the YTM calculation looks incorrect.

https://www.londonstockexchange.com/stock/TR28/united-kingdom/company-page

Its prospectus. Definitely 6%.

https://www.dmo.gov.uk/media/ukua1mip/prosp1805.pdf

Ahh I see. I have some interaction with bonds at work and have always seen fixed bonds with an annualised coupon rather than a rate per coupon period. You live and learn. 

The name of the bond states the annual coupon.

Ballard

Linton said:

Ballard said:

wmb194 said:

Ballard said:

I've just looked it up and it's showing a coupon rate of 3% rather than the 6% that has been quoted on this thread and a yield to maturity of -1.243 which doesn't look to be a good choice of investment to me.

You looked at the LSE? It looks like 3% is the next coupon - it pays twice a year - and the YTM calculation looks incorrect.

https://www.londonstockexchange.com/stock/TR28/united-kingdom/company-page

Its prospectus. Definitely 6%.

https://www.dmo.gov.uk/media/ukua1mip/prosp1805.pdf

Ahh I see. I have some interaction with bonds at work and have always seen fixed bonds with an annualised coupon rather than a rate per coupon period. You live and learn. 

The name of the bond states the annual coupon.

Indeed it does. I’d somehow managed to completely miss that. Being as I’ve been dealing with bonds at work for years that’s not a good sign (although I don’t have much involvement with them nowadays)!

GeoffTF

biscan25 said:

As an aside, that gilt would be a poor choice for a taxpayer if held outside a tax-free wrapper (ISA,SIPP etc.) as tax is paid on the interest, but not on the capital gain at the end.

The opposite is true for many gilts. You can buy gits with 0.125% coupons. They are either index linked or the current price is well below par. The total return from these gilts is almost all capital gain, which is tax free.

solidpro

Reviving this old post and trying to get my head around this. So, the coupons are the bi-annual interest payments?

Why does a 'dirty' price include the value of past interest - going back how long? I would understand if they're soaked up into the investment and all paid out in a lump sum at the end, but this suggests it isn't? Unless of course, the value ping pongs around every 6 months just before the next coupon comes around?

Using the OP's example on another poster's suggestion of HL:



Is this plummeting value in late 22 all to do with Liz Truss and her fabulous ideas from Tufton St?

Now that era is gone - for the short term, does this mean they're undervalued?

Finally, I don't understand why you would buy a 0.125% one instead of a 6% one?

Thanks

DavidT67

The dirty price includes the interest accrued but not yet paid out since the last coupon payment that's due to the seller.

UK Gilts are CGT exempt, so buying a low coupon bond, which will be valued below par, means you mostly receive capital gains on maturity, alongside the small interest payments, that's attractive to higher and additional rate taxpayers.

Sites such a YieldGimp and DividendData do the maths for you and show the post tax yields to maturity.

Linton

Just talking about fixed gilts. Inflation linked gilt pricing is more complex but in principle its the same. Note I am glossing over details to get the basics clear.

1) Suppose you buy a gilt on which interest is due on the 1st Jan and 1st July.  Say you buy the gilt on the 1st June.  You receive your interest payment a month later but this includes interest gained when you did not actually own the gilt.  The dirty price compensates for this.

2) The plummeting value in June 2022 was due to the rapid rise in interest rates at that time. Call it 1% going up to 5%. 

Now say you owned a gilt returning 1%.  When interest rates were generally at 1% the gilt would be priced at par ie £100. After rates shot up to  5% no-one wouild want to buy a 1% gilt and so the price would drop to a level at which the total return is the same as a 5% gilt.  Gilts will be priced such that their effective interest rate is equivalent to the current market rate. 

You can use this for tax optimisation.  If you buy a 5% gilt at par you will get £5 per gilt taxable interest until maturity.  If you buy 0.125% gilts you will get £0.125 interest but at maturity you will receive par value making an untaxed capital gain 

saajan_12

solidpro said:

Reviving this old post and trying to get my head around this. So, the coupons are the bi-annual interest payments?

Why does a 'dirty' price include the value of past interest payments? I would understand if they're soaked up into the investment and all paid out in a lump sum at the end, but this suggests it isn't? Unless of course, the value ping pongs around every 6 months just before the next coupon comes around?

Yes, coupon - interest which in this case is every 6 months. 
If you buy a bond, you receive any coupon payments with payment date during your ownership, nothing is saved up and paid at the end. Your example bond has coupons paid 6th Jan and 6th July each year. If you buy today, then you'll receive the full coupon on 6th Jan 2023. However the seller gets nothing for holding the bond between 7Jul24 - 26Sep24. So to account for that, you pay 2.5 months worth of interest to the seller upon purchase, ie £100 x 3% x 2.5/6 = £1.25 accrued interest. If you add that to the 'clean price' then you get the 'dirty' price. You'll effectively get the £1.25 back because you'll get the full coupon ie £3 on 6Jan25 despite only holding it for 3.5 months. 

solidpro said:

Is this plummeting value in late 22 all to do with Liz Truss and her fabulous ideas from Tufton St?

Now that era is gone - for the short term, does this mean they're undervalued?

Well 2022 is when interest rates rose globally, which drives bond prices down, not just for UK, not just Truss related. Think this is a bond paying 6%, most interest rates rose to ~5.5%, so why would anyone pay a premium for this bond when they could get the same interest in a bank account or buying a new bond at £100. Whereas in the years before, when the interest rates were 1-3%, then it would be worth paying an extra few £ to receive some more interest each year.  

solidpro said:

Finally, I don't understand why you would buy a 0.125% one instead of a 6% one?

Because the 0.125% bond will be cheaper.. say £90 to buy and £100 at maturity, so that difference is profit for you.  

solidpro

So....

The plummeting value in June 22 due to interest rates climbings is causing the value to drop because there is a lot more competition in the market? Surely the one shown above at 6% was 'good' then and it's 'good' now compared to overall investments? I could understand why a 0.125% one would drop in value when interest rates rise from 0.5% to 6% but I can't see why it would also affect a 6% gilt?

Does the interest rate ever change during the life of a guilt? If one was issued at 0.125% and then interest rates shoot up, surely no-body would buy one. Unless the buy price was well undervalued and you're planning on keeping it until the goverment is forced to buy it back at original value? 

Does that original value generally incorporate inflation in the years between it being issued and at maturity?

aroominyork

solidpro said:

Finally, I don't understand why you would buy a 0.125% one instead of a 6% one?

Because it would be cheaper. Look at two gilts maturing in the last quarter of 2028:

TG28 pays a 1.625% coupon and costs £92.38

TR28 pays a 6% coupon and costs £108.92.

The yield on both is about 3.65% pa. You might buy the lower coupon one because you pay tax on the dividend, so if you buy say 100,000 units that could be the difference between £1625*20%=£325 tax pa and £6000*20%=£1200 tax pa. The capital gain - the difference between the TG28 buying price of £92,380 and the maturity value of £100,000 - is not taxed. That is why there is so much chatter these days about low coupon nominal gilts.

Linton

solidpro said:

So....

The plummeting value in June 22 due to interest rates climbings is causing the value to drop because there is a lot more competition in the market? Surely the one shown above at 6% was 'good' then and it's 'good' now compared to overall investments? I could understand why a 0.125% one would drop in value when interest rates rise from 0.5% to 6% but I can't see why it would also affect a 6% gilt?

Does the interest rate ever change during the life of a guilt? If one was issued at 0.125% and then interest rates shoot up, surely no-body would buy one. Unless the buy price was well undervalued and you're planning on keeping it until the goverment is forced to buy it back at original value? 

Does that original value generally incorporate inflation in the years between it being issued and at maturity?

A 6% gilt pays £6/year no matter what the price is - 6% means 6% of the face value which in the case of fixed gilts is always £100.  You will notice on your example gilt that its price is about £109 but on maturity you would only get £100 so its higher interest is offset by a capital loss.

Gilts are never over valued or under valued.  They are priced at the exact value they should be given the market interest rates and the time you have to wait to get £100 back.

Evrybody knows that a gilt on maturity will pay £100 so its price will approach £100 the nearer you get to maturity.  Which is why short dated gilts are not as volatile as long dated ones.

Fixed rate gilts are not directly affected by inflation but the market rates which drive gilt prices are.