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Most people used to buy a fixed interest security for the income it provides and the guaranteed capital sum payable at the end of its term. But because many stocks were issued at a time when interest rates were considerably higher than they are today, such stocks often now only offer a guaranteed loss if you hold them to maturity.
During the life of the stock however, it can be traded on the Stock Exchange and its price will vary according to supply and demand giving you the chance to make a capital profit. This does not apply to National Savings and Local Authority Loans which are not tradeable.
Gilt-edged
These stocks are issued and guaranteed by the British Government, so there is no question of the dividend not being paid or the funds not being available when the stock matures. A company may go bust, but should the Government get into financial trouble it simply raises taxes or sells an asset.
The many different gilt stocks available are divided into three groups according to their maturity dates.
Shorts are Gilts with less than five years to run before redemption, mediums have five to 15 years to run, and the remainder are called longs. Then there are a few Gilts such as 4% Consols and 3% War Stock which have no maturity dates.
The names given to the stocks such as Treasury, Exchequer, Funding, Consols are irrelevant to the investor. The important factors are the rate of interest, the length of time before redemption and the current market price.
The current market price of a gilt is determined mainly by the general level of interest rates. If interest rates are low then many Gilts stand at a premium, i.e. a price higher than the redemption price. If interest rates are high the price stand at a discount, ie a price lower than the redemption price.
But remember, the stock market is always looking to the future. If the market thinks that we are in for an inflationary period and interest rates will be higher when the gilt matures then it will not be considered a good investment and may stand at a discount.
To trade in Gilts you must take a view of the future movement of interest rates and back your judgement. The prices of the longer dated Gilts usually fluctuate the most because the shorter dated issues tend to move towards their par (redemption) value as the redemption date draws near. However, a sudden fall in interest rates could see a sharp rise in the price of short-dated Gilts. You must make a thorough study of the market before you start trading.
Some investors use Gilts as a means of reducing their tax bills. They buy stock giving a low rate of interest which is taxable, but offers substantial capital appreciation which is not taxable.
Interest yield
If you bought a 8% Treasury Stock 2010 at 120 in 2004, you will pay £120 for each £100's worth of stock. Because you paid £20 more than the par (redemption) value of the stock you will obviously not receive 8 % interest per annum on your investment but effectively only 6.6 %. This figure is known as the interest yield. You are also guaranteed a capital loss when the stock matures in 2010.
Redemption yield
To carry the point a stage further if you keep the stock until its redemption date in 2010 and collect the £100 due your total return, in capital and income terms, will only be, say 5% a year. This figure is known as the redemption yield.
Index-linked
With a long-term investment of Gilts there is always the danger that your capital will be severely diminished by inflation. Hence, the introduction in 1982 of index-linked stocks in which both capital and income are increased in accordance with the UK Retail Prices Index. There are similar stocks issued by the US and other foreign Governments denominated in their own currencies and using their own inflation index. For details of the UK, US and French stocks see www.Investment Guide.co.uk.
How to buy
You can deal in gilt-edged stock through your stockbroker. Generally, the commission charged is slightly less than for equities, although the minimum charge of £15 or £20 for small amounts usually applies.
Alternatively, you can get an application form from your local post office for a minimum charge of £ 1. The disadvantage is that you will not receive details of the transaction for about three days.
Other fixed interest stocks
These are now often called Corporate Bonds. They are stocks issued by companies which bear the added risk that the company may go bust and be unable to pay out when the loan matures. The market price is therefore influenced by the standing of the company as well as interest rates in general. Those which are technically debentures are secured on the company's assets and are less likely to default than unsecured stocks. A number of companies such as Moodies and Standard & Poors publish risk ratings for corporate and government stocks. The more risk, the higher the yield.
Check List
1. Before attempting to trade in Gilts or other fixed interest securities it is essential to make a thorough study of the market.
2. If you are thinking of buying a gilt as an investment get expert advice. The right gilt for you depends very much on your individual circumstances, e.g. your tax position and when you want your money back.
3. Never buy Gilts when interest rates are rising - or are expected to rise.
Last updated 19
January 2008.