Easy explanation of gilts please

Mrskingy

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:

SandyHood

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

SandyHood

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%

SandyHood

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