Index Linked Gilts

horace972897

Hi

I wonder if I could check my understanding of Index linked gilt pricing and what you get back on maturity?

My understanding:

If i want to buy £10000 of a fictious particular bond which has maturity date of 01/10/2027, a clean price of £100 and a dirty price of £200 i would end up with (£10000/£200)*100 Whole nominal £100 gilts (i.e. 5000 whole £100 bonds)  and on maturity i would get back £10000 in todays money or £10000 plus inflation on the 1st of Jan 2027.

Is my understanding correct?

i.e. the amount I pay for the bond when bought (not including the fee's) is same number i get back on maturity plus inflation (unless we have deflation or the UK gov defaults i guess).

On top of the above i would also get the coupon percentage (plus inflation)  every six months or so (based on when the couplon is paid)

Thanks in advance - Horace

masonic

Yes, that's roughly true. There is a lag in the RPI figure used, so index linking doesn't exactly match the period you hold the investment, but this is probably not a bad thing with inflation falling.

Linton

horace972897 said:

Hi

I wonder if I could check my understanding of Index linked gilt pricing and what you get back on maturity?

My understanding:

If i want to buy £10000 of a fictious particular bond which has maturity date of 01/10/2027, a clean price of £100 and a dirty price of £200 i would end up with (£10000/£200)*100 Whole nominal £100 gilts (i.e. 5000 whole £100 bonds)  and on maturity i would get back £10000 in todays money or £10000 plus inflation on the 1st of Jan 2027.

Is my understanding correct?

i.e. the amount I pay for the bond when bought (not including the fee's) is same number i get back on maturity plus inflation (unless we have deflation or the UK gov defaults i guess).

On top of the above i would also get the coupon percentage (plus inflation)  every six months or so (based on when the couplon is paid)

Thanks in advance - Horace

Not necessarily....

Bonds are issued with a face value of £100.  If you hold an index linked bond the £100 is increased by inflation until it matures.  However before maturity the price of the bond can be quite volatile depending on the behaviour of interest rates and the time to maturity.

So if you paid £10000  for IL bonds when their clean price was £110 you would get back 100/110 of  £10000 inflated by RPI since the time you bought the bonds and the interest paid would be 100/110 of the coupon, also increased by inflation.

zagfles

horace972897 said:

Hi

I wonder if I could check my understanding of Index linked gilt pricing and what you get back on maturity?

My understanding:

If i want to buy £10000 of a fictious particular bond which has maturity date of 01/10/2027, a clean price of £100 and a dirty price of £200 i would end up with (£10000/£200)*100 Whole nominal £100 gilts (i.e. 5000 whole £100 bonds)  and on maturity i would get back £10000 in todays money or £10000 plus inflation on the 1st of Jan 2027.

Is my understanding correct?

i.e. the amount I pay for the bond when bought (not including the fee's) is same number i get back on maturity plus inflation (unless we have deflation or the UK gov defaults i guess).

On top of the above i would also get the coupon percentage (plus inflation)  every six months or so (based on when the couplon is paid)

Thanks in advance - Horace

Sort of but you seem to be mixing up the two types of IL gilts.

Pre-2005 gilts already include inflation in the "clean" price, so the dirty price is just the clean price plus the coupon to date, and those have an 8 month indexation lag. 

Post-2005 gilts clean prices don't include inflation so the dirty price is the clean price x the indexation since issue, plus the accrued coupon, and they have a 3 month indexation lag

Your example seems to assuming the post 2005 pricing but the pre 2005 indexation lag. 

horace972897

zagfles said:

horace972897 said:

Hi

I wonder if I could check my understanding of Index linked gilt pricing and what you get back on maturity?

My understanding:

If i want to buy £10000 of a fictious particular bond which has maturity date of 01/10/2027, a clean price of £100 and a dirty price of £200 i would end up with (£10000/£200)*100 Whole nominal £100 gilts (i.e. 5000 whole £100 bonds)  and on maturity i would get back £10000 in todays money or £10000 plus inflation on the 1st of Jan 2027.

Is my understanding correct?

i.e. the amount I pay for the bond when bought (not including the fee's) is same number i get back on maturity plus inflation (unless we have deflation or the UK gov defaults i guess).

On top of the above i would also get the coupon percentage (plus inflation)  every six months or so (based on when the couplon is paid)

Thanks in advance - Horace

Sort of but you seem to be mixing up the two types of IL gilts.

Pre-2005 gilts already include inflation in the "clean" price, so the dirty price is just the clean price plus the coupon to date, and those have an 8 month indexation lag. 

Post-2005 gilts clean prices don't include inflation so the dirty price is the clean price x the indexation since issue, plus the accrued coupon, and they have a 3 month indexation lag

Your example seems to assuming the post 2005 pricing but the pre 2005 indexation lag. 

Hi Zagfles

I think you're getting the pre 2005 lag from my typo of the redemption date - i was in fact ignoring the lag and the redeption date should have read 01/01/2027 rather than 01/10/2027

Horace

horace972897

Linton said:

horace972897 said:

Hi

I wonder if I could check my understanding of Index linked gilt pricing and what you get back on maturity?

My understanding:

If i want to buy £10000 of a fictious particular bond which has maturity date of 01/10/2027, a clean price of £100 and a dirty price of £200 i would end up with (£10000/£200)*100 Whole nominal £100 gilts (i.e. 5000 whole £100 bonds)  and on maturity i would get back £10000 in todays money or £10000 plus inflation on the 1st of Jan 2027.

Is my understanding correct?

i.e. the amount I pay for the bond when bought (not including the fee's) is same number i get back on maturity plus inflation (unless we have deflation or the UK gov defaults i guess).

On top of the above i would also get the coupon percentage (plus inflation)  every six months or so (based on when the couplon is paid)

Thanks in advance - Horace

Not necessarily....

Bonds are issued with a face value of £100.  If you hold an index linked bond the £100 is increased by inflation until it matures.  However before maturity the price of the bond can be quite volatile depending on the behaviour of interest rates and the time to maturity.

So if you paid £10000  for IL bonds when their clean price was £110 you would get back 100/110 of  £10000 inflated by RPI since the time you bought the bonds and the interest paid would be 100/110 of the coupon, also increased by inflation.

Thanks Linton - more food for thought - I really need to work out the formula for working out expected redemption figures (albeit based on assumed inflation figures) as i really don't want to blindly trust the various spreadsheets/ tools floating about on this subject at the moment. Some are suggesting buying bonds that have a clean price in the 200's - 300's which concerns me with regard to the redemption figures

horace972897

zagfles said:

horace972897 said:

Hi

I wonder if I could check my understanding of Index linked gilt pricing and what you get back on maturity?

My understanding:

If i want to buy £10000 of a fictious particular bond which has maturity date of 01/10/2027, a clean price of £100 and a dirty price of £200 i would end up with (£10000/£200)*100 Whole nominal £100 gilts (i.e. 5000 whole £100 bonds)  and on maturity i would get back £10000 in todays money or £10000 plus inflation on the 1st of Jan 2027.

Is my understanding correct?

i.e. the amount I pay for the bond when bought (not including the fee's) is same number i get back on maturity plus inflation (unless we have deflation or the UK gov defaults i guess).

On top of the above i would also get the coupon percentage (plus inflation)  every six months or so (based on when the couplon is paid)

Thanks in advance - Horace

Sort of but you seem to be mixing up the two types of IL gilts.

Pre-2005 gilts already include inflation in the "clean" price, so the dirty price is just the clean price plus the coupon to date, and those have an 8 month indexation lag. 

Post-2005 gilts clean prices don't include inflation so the dirty price is the clean price x the indexation since issue, plus the accrued coupon, and they have a 3 month indexation lag

Your example seems to assuming the post 2005 pricing but the pre 2005 indexation lag. 

Ah - maybe a lightbulb moment - the bond i was looking at that has a clean price of 350 ish was a pre-2005 one so is the redemption value calculated differently than 10000/350*100 (inflated by RPI)?

easysaver

horace972897 said:

Linton said:

horace972897 said:

Hi

I wonder if I could check my understanding of Index linked gilt pricing and what you get back on maturity?

My understanding:

If i want to buy £10000 of a fictious particular bond which has maturity date of 01/10/2027, a clean price of £100 and a dirty price of £200 i would end up with (£10000/£200)*100 Whole nominal £100 gilts (i.e. 5000 whole £100 bonds)  and on maturity i would get back £10000 in todays money or £10000 plus inflation on the 1st of Jan 2027.

Is my understanding correct?

i.e. the amount I pay for the bond when bought (not including the fee's) is same number i get back on maturity plus inflation (unless we have deflation or the UK gov defaults i guess).

On top of the above i would also get the coupon percentage (plus inflation)  every six months or so (based on when the couplon is paid)

Thanks in advance - Horace

Not necessarily....

Bonds are issued with a face value of £100.  If you hold an index linked bond the £100 is increased by inflation until it matures.  However before maturity the price of the bond can be quite volatile depending on the behaviour of interest rates and the time to maturity.

So if you paid £10000  for IL bonds when their clean price was £110 you would get back 100/110 of  £10000 inflated by RPI since the time you bought the bonds and the interest paid would be 100/110 of the coupon, also increased by inflation.

Thanks Linton - more food for thought - I really need to work out the formula for working out expected redemption figures (albeit based on assumed inflation figures) as i really don't want to blindly trust the various spreadsheets/ tools floating about on this subject at the moment. Some are suggesting buying bonds that have a clean price in the 200's - 300's which concerns me with regard to the redemption figures

In case you're not aware the DMO have a report on redemption estimates...
https://www.dmo.gov.uk/data/pdfdatareport?reportCode=D9C

zagfles

horace972897 said:

zagfles said:

horace972897 said:

Hi

I wonder if I could check my understanding of Index linked gilt pricing and what you get back on maturity?

My understanding:

If i want to buy £10000 of a fictious particular bond which has maturity date of 01/10/2027, a clean price of £100 and a dirty price of £200 i would end up with (£10000/£200)*100 Whole nominal £100 gilts (i.e. 5000 whole £100 bonds)  and on maturity i would get back £10000 in todays money or £10000 plus inflation on the 1st of Jan 2027.

Is my understanding correct?

i.e. the amount I pay for the bond when bought (not including the fee's) is same number i get back on maturity plus inflation (unless we have deflation or the UK gov defaults i guess).

On top of the above i would also get the coupon percentage (plus inflation)  every six months or so (based on when the couplon is paid)

Thanks in advance - Horace

Sort of but you seem to be mixing up the two types of IL gilts.

Pre-2005 gilts already include inflation in the "clean" price, so the dirty price is just the clean price plus the coupon to date, and those have an 8 month indexation lag. 

Post-2005 gilts clean prices don't include inflation so the dirty price is the clean price x the indexation since issue, plus the accrued coupon, and they have a 3 month indexation lag

Your example seems to assuming the post 2005 pricing but the pre 2005 indexation lag. 

Ah - maybe a lightbulb moment - the bond i was looking at that has a clean price of 350 ish was a pre-2005 one so is the redemption value calculated differently than 10000/350*100 (inflated by RPI)?

Presume it's T30I, the current index ratio is about 2.76 so you'll get 276 increased by inflation (from 8 months ago until 8 months before redemption), so if you buy at 350 and hold till redemeption you'll make a real terms capital loss of about 21% but will get 4.125% interest on the indexed face value which would be about 3.84% on your investment. Not worked it out properly but looks like you'd make a very small real terms gain with this one.

Loads of information on IL gilts here https://www.dmo.gov.uk/data/gilt-market/index-linked-gilts/

Reg_Smeeton

zagfles said:

Presume it's T30I, the current index ratio is about 2.76 so you'll get 276 increased by inflation (from 8 months ago until 8 months before redemption), so if you buy at 350 and hold till redemeption you'll make a real terms capital loss of about 21% but will get 4.125% interest on the indexed face value which would be about 3.84% on your investment. Not worked it out properly but looks like you'd make a very small real terms gain with this one.

Loads of information on IL gilts here https://www.dmo.gov.uk/data/gilt-market/index-linked-gilts/

Sorry to crash the thread but found this such a useful post, would you mind double checking my understanding?

So for any IL gilt, the calculation is (Current Index Ratio/Dirty price)+(coupon amount x years to maturity)=capital gain/loss on redemption 

Have I got that within spitting distance?

zagfles

Reg_Smeeton said:

zagfles said:

Presume it's T30I, the current index ratio is about 2.76 so you'll get 276 increased by inflation (from 8 months ago until 8 months before redemption), so if you buy at 350 and hold till redemeption you'll make a real terms capital loss of about 21% but will get 4.125% interest on the indexed face value which would be about 3.84% on your investment. Not worked it out properly but looks like you'd make a very small real terms gain with this one.

Loads of information on IL gilts here https://www.dmo.gov.uk/data/gilt-market/index-linked-gilts/

Sorry to crash the thread but found this such a useful post, would you mind double checking my understanding?

So for any IL gilt, the calculation is (Current Index Ratio/Dirty price)+(coupon amount x years to maturity)=capital gain/loss on redemption 

Have I got that within spitting distance?

No the capital gain/loss has nothing to do with the coupon, it's just the difference between the price you pay when you buy and the price you get at maturity (or when you sell), ie purely the capital.

The YTM (yield to maturity) accounts for the capital gain/loss. Loads online about how to calculate this, but for IL gilts I just think of everything in real terms.

So for high coupon gilts like T30I you'll always make a (real terms) capital loss if held to maturity but that's compensated for by the high coupon, and for low coupon gilts you might make a capital gain. Usually they work out about the same YTM. Tax is different though - if held unwrapped there's no tax on the capital gain but there is on the coupon. So holding high coupon gilts unwrapped may not be a good idea, may be better in a SIPP/ISA.