New to Investing in Gilts

Aminatidi

Silly question here but...

When using sites like yieldgimp does the yield compound i.e. if you put £100K in a gilt with 3 years to maturity on a 5% YTM is it compounded?

I'm struggling with that part because some it capital gain and some is coupon and the coupon is "cash" so once paid presumably that's that on that portion of the return.

Hope I've explained that sensibly.

masonic

Aminatidi said:

Silly question here but...

When using sites like yieldgimp does the yield compound i.e. if you put £100K in a gilt with 3 years to maturity on a 5% YTM is it compounded?

I'm struggling with that part because some it capital gain and some is coupon and the coupon is "cash" so once paid presumably that's that on that portion of the return.

Hope I've explained that sensibly.

Normally YTM calculations are done on the basis of reinvestment of income, so if you cannot reinvest at the same rate of return your result will differ slightly. For low coupon gilts and/or short time periods, this will be fairly insignificant.

Aminatidi

Thank you that makes sense especially around the low coupon part.

Main thing is the rest is assumed to compound so I can get a reasonably sensible idea using a compound interest calculator.

I think Einstein had a point as it's scary what "just" 5% looks like after a few years 

mda99das

I was looking at some of the maths used to calculate inflation linked bonds, and its pretty horrific.
I am struggling to understand how the ROI is calculated.

There is an example here:
https://www.dmo.gov.uk/responsibilities/gilt-market/about-gilts/

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 3.75%, giving a yield-to-maturity of about 4.53%. 
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I don't get something, it says 3.25% if you paid £100 ie the face value, and then if you paid a discount ie £90 you get 3.75%. Am I missing something, or is this a mistake their end in the example.

Lets say the coupon is £3.25
I calculated it the following
Buy the bond @ £90 and after 10 years get £100 back. Every year you get coupon paid = £3.25. After 10 years you get £100 + 10*3.25 =  £132.50
£132.50 / £90 =  147% return after 10 years.
To look at the return per year, you would want to take the 10th root.  1.47222222...^(1/10) =  subtracting the 1 gives 3.94% as an annualized return of £90 invested.

Can someone please explain where I am going wrong? many thanks

masonic

Looks like a typo to me. They say thecoupon is 3.25% in places and 3.75% in others, but they are referring to one gilt with one coupon rate. They've used the wrong coupon for the calculation.

Cold_comfort

The 3.75% does seem to be a typo. With a 3.25% coupon rate, you'd get 3.25% of the £100 face value each year. This could also be expressed as 3.61% of the £90 price paid. But not 3.75%!

However, the calculated yield-to-maturity is correct. What you need to allow for is that redemption yield calculations assume the investor reinvests the interest payments received by buying more of the gilt at the same redemption yield.

You can replicate the calculation approximately by adding interest to each year's coupon up to the maturity date. In the example, the first year's coupons of £3.25 are effectively assumed to get another 9 years' interest (so it's taken as £3.25 x 1.0453^9 = £4.84 at maturity), the second year 8 years (£3.25 x 1.0453^8 = £4.63) etc. until the final year's coupons of £3.25 at maturity with no interest. (I'm ignoring that in practice coupons are paid half-yearly.)

In total, the coupons with interest at 4.53% come to just under £40. Adding the maturity proceeds of £100 gives £140.

This is roughly equivalent to the purchase price of £90 with 10 years' interest i.e. £90 x 1.0453^10 = about £140, thereby confirming 4.53% is the correct yield.
 

mda99das

Thanks for that, it clarifies things. Another thing I saw was short dated bond. 

I am looking at UK 3 month gilts 

There isn't a defined coupon for this.

https://uk.investing.com/rates-bonds/uk-3-month-bond-yield

The last closing price was 98.709 . I can see the yields on this fluctuate on a daily basis . Right now its 5.5570.

In terms of the return on investment am I right in thinking for every £98.709 invested I would get £100 back after the 3 months are up?

And the interest is calculated daily? Or would it be averaged out over the 3 months? Is it wishful thinking that I would get 5.5570% on £100 after 3 months or would I get 3/12 of it ie a quarter?

Many thanks

Aminatidi

Don't think you can buy those as a retail customer though.

oz0707

excuse my ignorance and slight hijack does these yields mean the TN24 is offering the equivalent of roughly 4.73% (per annum pro rata) if held to redemption but with minimal tax (only tax on the 'interest'?). I might have to look at getting some of these they are effectively cutting the tax on existing savings rates and only locking money up for 5 months

Aminatidi

Basically yes.

The coupon is taxable.

The capital gain isn't.

So if you look at TN28 which I'm almost settled on it's selling at roughly 82.31 so there's a capital gain of approx 21% that's entirely tax free and the coupon is 0.125% which is minimal but counts towards tax allowances.