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Easy explanation of gilts please

MrskingyMrskingy Settling In NicelyRegistered Posts: 20
I am sitting a simulation for Unit 15 Cash management and credit control on Friday and I am still struggling with understanding gilts.
Is there an easy way? I have the Kaplan book and I'm totally confused with how to work out the redemption yield and interest yield.
Please, please can someone help me?

:confused1::confused1::confused1:

Comments

  • SandyHoodSandyHood Font Of All Knowledge Registered, Moderator Posts: 2,034
    Redemption yield.

    The yield to maturity (YTM) of a bond is the IRR that a buyer would receive if they purchased the bond at the current market price. This is also called the redemption yield.

    Say we have a gilt with a repayment date of 30th April 2013 paying 4% annually on 30th April and that this £100 bond can be bought on 1st May for its market value of £95.

    We have a negative cash flow of £95 1st May 2009 and then positive cash flows of £4 on 30th April 2010, 2011, and 2012 and positive cash flow of £104 on 30th April 2013.

    So we can lay out the calculation as follows:
    Year....................Cash flow....................discount rate (7%)....................present value
    2009....................(£95)...........................1.00..............................(£95)
    2010....................£4................................0.935..............................£3.74
    2011....................£4................................0.873..............................£3.49
    2012....................£4................................0.816..............................£3.27
    2013....................£104.............................0.763.............................£79.34
    Net Present Value.........................................................................(£5.16)

    This tells us that the yield is lower than 7% as the 7% discount rate produced a negative NPV

    So we can lay out the calculation as follows:
    Year....................Cash flow....................discount rate (5%)....................present value
    2009....................(£95)...........................1.00..............................(£95)
    2010....................£4................................0.952..............................£3.81
    2011....................£4................................0.907..............................£3.63
    2012....................£4................................0.864..............................£3.46
    2013....................£104.............................0.823.............................£85.56
    Net Present Value.........................................................................£1.46

    This tells us the return is higher than 5%

    So we find the yield by finding the proportion of the difference between 5% and 7% and add it to the 5%
    .............(1.46
    5% + .((5.16+1.46).. x 7% - 5%)
    = 5% +0.44% = 5.4% redemption yield
    Sandy
    [email protected]
    www.sandyhood.com
  • SandyHoodSandyHood Font Of All Knowledge Registered, Moderator Posts: 2,034
    Interest yield

    This is easier to calculate but less useful

    Simply look at the annual cash that the bond pays (£4) and find what % this represents of the cost (£95)

    ,,,.,,,£4
    ,,,..,£95,,,..,= 4.2%
    Sandy
    [email protected]
    www.sandyhood.com
  • SandyHoodSandyHood Font Of All Knowledge Registered, Moderator Posts: 2,034
    I'd be surprised to see these questions appear on a unit 15 simulation
    1. Remption yield would need discount factors to be provided, and in the past they haven't been.
    2. Interest yield produces a %, but it doesn't really tell you the return the investor will get because it is so limited in terms of the calculation
    Sandy
    [email protected]
    www.sandyhood.com
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