gilt securities

Registered Posts: 121 ? ? ?
Hello (AGAIN)

I'm sorry I'm becoming a bit of a pain with all these questions but. . . .

Does anyone have an idiots guide to gilt securities redemption yield/flat yield etc. I asked my tutor but didnt have any hand outs on this subject.

I need to complete this task on my practise simulation by tomorrow!!!

THANK YOU SO MUCH!!!!

• Registered, Moderator Posts: 2,034
Have you tried a search?

try [post=113082]this it sets up 3[/post]

and [post=142797]another on redemption with calculations[/post]
Sandy
[email protected]
www.sandyhood.com
• Registered, Moderator Posts: 2,034
The following is an updated version of a reply I wrote in 2003.
It is long and has an example, and probably goes beyond your question but I hope it helps.
The link took you to the old discussion forum which tends to mess up the font, so I've added this.

Treasury stock can be issued by the government at £100 each. These are tradable, so if you had bought your stock from the government when they were issued, rather than wait until 2020 to sell them back, you could sell them to me.

But how much will you get if you sell them?

The formula for this is beyond the AAT syllabus, but does have a lot in common with net present values from Intermediate ECR
At 7% whoever buys the stock is buying the entitlement to £7 every year.
We will not look at whether it is once a year or not, just assume it is one payment of £7 (7% of £100) for every stock held and is paid annually.

To work out the flat yield you look at the value of all the future interest payments of £7 and compare this with the investment cost. In this case the £110 re-sale value of the stock will generate a return of 6.36%.

To work out the redemption yield you look at all the money that you will get back and discount the receipts to their present values: the £100 from the government as well as the interest payments. So because it is currently trading at £110 the redemption yield works out lower than the flat yield (but this is more accurate)
I hope that gives you an idea of what you are looking at with gilts.

Now if you compare buying stocks at £110 with a 7% interest payment each year and a reimbursement of £100 at the end of 2010 with putting the money in the bank, there is a direct comparison. The stock will generate 3.8% if held until redemption, whereas the bank deposit will only generate 3%.
I don’t think the question requires any figures, but I’ve put some in to try to help.

Imagine that today is 1st Jan 2010 and we have £100,000.
We can deposit this in the bank and receive £3,000 on 31 Dec 2010, another £3,000 on 31 December 2011 and another £3,000 on 31 December 2012. Plus we will get our £100,000 back on 31 December 2020.
Or we can buy treasury stock (second hand) at £110 for every £100 stock. If so we would probably buy 909 at £110 each. This would generate an income of £6,363 on the 31 December each year and we would get (909 x £100) £90,900 back on 31 December 2020.

Why is the current price of the stock £110 when it was issued at £100? The interest on this gilt is fixed. So once £7 per £100 (7%) has been set it cannot change. This means that the holder of the bond could have a higher return than the market rate. Interest rates can go up and down in the market. If the market rate is 6%, then a guaranteed income of £7 per year would cost £110. In other words anyone wanting to earn £7 interest would have to put £110 into an account paying 6%. This means that if you hold government stock paying £7 it is worth £110 and you can sell it for £110 even if it had originally cost you £110. I know this is quite a long reply. Please let me know if you would like any part made clearer.

Sandy
Sandy
[email protected]
www.sandyhood.com
• Registered Posts: 121 ? ? ?
thank you so much that makes it alot clearer. (alot more than I got from my tutor!!)
• Registered Posts: 121 ? ? ?
I'm sorry one more question!!!!

Am I right in thinking the disadvantages of this type of investment would be the additional fees that would be incurred buying and selling via a broker? also if the interest rate were to rise then as these are fixed the return would reduce in comparison?

I'm struggling to think of any more!!!

Thank you so much in advance!!
• Registered, Moderator Posts: 2,034