Return on capital for TR24 inflation linked gilt

chinadolltj

Hi all,

After reading various post, I'm still a bit baffled to understand what will be the return on capital for TR24 gilt. 

Say if I purchase this gilt now, will the RPI be used on a monthly bases between June 2023 to Dec 2023? I see the RPI is going down from June to July, does this indicate that I will be making a capital lost if the RPI is trending downward?

Many thanks for your answer and guidance in advance.

OldScientist

The RPI rate is going down, but the prices of goods are still going up. Likewise, with inflation linked gilts, the price at maturity will be increasing with RPI (although the price before maturity will depend on both inflation and yields).

spider42

OldScientist said:

The RPI rate is going down, but the prices of goods are still going up. Likewise, with inflation linked gilts, the price at maturity will be increasing with RPI (although the price before maturity will depend on both inflation and yields).

The OP was correct to say that RPI fell between June and July. It wasn't just the rate that fell, RPI itself fell from 376.4 to 374.2, a drop of 0.6% in a single month. CPI also fell.

JohnWinder

You need to go beyond reading posts here. If you want to know how the adjusted face value of a linker varies with the RPI, or whatever it varies with, and how often and after what interval do the adjustments occur, then you should read the prospectus or some Treasury or Bank of England explanation for linkers in general.

Whether you’ll get a capital loss or otherwise, obviously depends on buying and redemption prices (assuming it is redeemed in Dec ‘23). One can find out what the adjusted face value is now because all the adjustments are publicly announced, so someone will be tabulating the changing face value. That value will move again depending on RPI (or whatever the index used is) changes between the now value and the redemption value; you can only guess what that will be.

As for the buying price, that should be easy to find out, but remember it might be quite different from the adjusted face value if the coupon for the linker is quite different from the current yield on those bonds. If the linker in question has a very high coupon, making it attractive to buy, then the price will also be high in response to its popularity; that high price will fall back to the adjusted face value at maturity, so if the bond is close to maturity there wouldn’t be far for its price to fall, since there aren’t many high interest coupons to receive in that short period between purchase and maturity. Does that get to the questions you raised?

OldScientist

spider42 said:

OldScientist said:

The RPI rate is going down, but the prices of goods are still going up. Likewise, with inflation linked gilts, the price at maturity will be increasing with RPI (although the price before maturity will depend on both inflation and yields).

The OP was correct to say that RPI fell between June and July. It wasn't just the rate that fell, RPI itself fell from 376.4 to 374.2, a drop of 0.6% in a single month. CPI also fell.

My apologies - you and the OP are correct. I was thinking of the annual rate which, in the context of linkers, is irrelevant.

The document at https://www.dmo.gov.uk/media/0ltegugd/igcalc.pdf indicates the details of how the cash flows and redemption payments are calculated.

chinadolltj

Thank you all for your valuable answers. I used this link to calculate redemption payment: https://www.dmo.gov.uk/data/pdfdatareport?reportCode=D9C and entered inflation assumption of 6%, it came out with £158.68 for nominal value of £100. That is a 58.68% increase. Is my understanding correct that this apply to the entire life span of the gilt (12 Oct 2012 - 22 Mar 2024 roughly 11.5 years) and a yearly return for redemption payment is 58.58%/11.5 = 5%? There is also a small coupon payment as well. 

JohnWinder

I think that’s right, pretty much. Except that one rarely buys for the £100 face value, even on the day it was issued. Why? Because the bond has a promised coupon, say 1%/year. If, on the day it is issued, or any time thereafter when you buy it, the market has set a yield for a bond maturing when this one does at 2%, then you’ll be able to buy the bond for less than £100 as compensation for accepting a coupon payment less than other bond holders will be getting. Essentially, the return is both coupon and capital gain/loss; with some bonds maturing on the same day as some others, one will be giving more interest and less capital gain, and vice versa.
Secondly, you’ve calculated arithmetic averages. You really should calculate compound annual average return; it’s a bit lower.

Linton

chinadolltj said:

Thank you all for your valuable answers. I used this link to calculate redemption payment: https://www.dmo.gov.uk/data/pdfdatareport?reportCode=D9C and entered inflation assumption of 6%, it came out with £158.68 for nominal value of £100. That is a 58.68% increase. Is my understanding correct that this apply to the entire life span of the gilt (12 Oct 2012 - 22 Mar 2024 roughly 11.5 years) and a yearly return for redemption payment is 58.58%/11.5 = 5%? There is also a small coupon payment as well. 

The inflation increase is compounded so using your figures  it's an average annual capital return over the lifetime of the gilt of 1.5868^(1/11.5)=1.040966-> 4.1%.    The total rise in RPI since October 2012 is about 58%.

However the return that you get depends on when you bought the gilt and how much you paid.

Andreg

If you bought the bond today, the index ratio for tomorrow's settlement is 1.54663.  With a price of 98.85 (say) that is a cost of £152.88 per £100nominal.  Assuming that RPI for maturity is 381 (i.e. interpolation from December RPI to January RPI - neither of which numbers we will know until mid January), that is an index ratio at maturity of 1.57151, and a maturity payment (including coupon) of £157.25 per £100nominal.  Total return of 2.9% over 6 months, i.e. 5.8%pa, which is approximately equivalent to inflation plus 2.5%pa.

Minus dealing fees, mid-offer spread (98.85 is the mid price currently), and income tax on the coupon.