Learn 100% online from anywhere in the world. Enroll today!

Gilts

Debt securities that are issued by the Bank of England, by His or Her Majesty’s treasury, and are listed on the London Stock Exchange (LSE)

What are Gilts?

Gilts are bonds issued by the UK government. More specifically, the debt securities are issued by the Bank of England, by His or Her Majesty’s treasury, and are listed on the London Stock Exchange (LSE). The term is also used in other Commonwealth nations, such as India or South Africa. However, typically, the term gilt is in reference to UK gilts.

 

Gilts
Source

 

The notion of “gilt-edged” may sometimes be used to underline that they are high-grade securities that carry low yields and, therefore, are less risky. Some banks and securities are registered with the Bank of England and are, therefore, obligated to take part in gilt auctions. In such a case, they are known as Gilt-edged Market Makers (GEMMs).

 

Summary

  • Gilts are bonds issued by the UK government. The first gilt issuance was in 1694 to King William III who needed to borrow 1.2 million pounds to fund a war against France.
  • In conventional gilts, the government will pay the holder a coupon, or cash payment, every six months until maturity.
  • Index-linked gilts pay coupons that are set in line with market interest rates, semi-annual coupons, and principal payments that are in line with the General Index of Retail Prices (RPI).

 

History of Gilts

Technically, the first gilt issuance was in 1694. King William III needed to borrow GBP1.2 million in order to fund a war against France. At the time, the Bank of England was newly created and was the one that was able to issue the money. Interestingly, however, the term gilt was not used until the late 19th century.

In future years, gilts became a successful form of government borrowing in the case of wars and infrastructure expansions. Initially, the issues did not come with a fixed maturity date and were issued under multiple names. Eventually, they became known as Consols. Moreover, there once was a time of undated or double-dated gilts. However, around 2013-2015, the last remaining gilts were redeemed.

 

What are Gilt Strips?

It is important to note that starting in 1997, gilts can essentially be stripped into their individual cash flows. The principal and interest can then be traded separately as what are known as zero-coupon gilts or gilt strips.

To be explained further, a 5-year gilt can be stripped into 11 separate securities. Ten strips based on the coupons will each get one semi-annual payment and the remaining strip will be entitled to the redemption payment after five years.

 

Importance of Gilts

Gilts are important to both the government and society. For the government, they will need to issue gilts to raise capital for their growing country, i.e., to build new infrastructure. For society, if gilts did not exist or yields rose, the government might need to raise taxes because they must find another way to pay for the infrastructure needs. Additionally, the interest rates affected will also affect individuals in areas such as mortgage loans or credit loans.

 

Example

  • 1½ Treasury Gilt 2050

It will require the principal to be repaid in 2050. The semi-annual payment will be made exactly six months apart, so January 1, 2020 and June 1, 2020 in the first year. The interest rate listed at the beginning of the name is decided based on market rates.

 

Conventional Gilts vs. Index-linked Gilts

Conventional gilts are the most generic form of UK government bonds. The conventional type of gilts also accounts for the largest share of the gilt portfolio. In such a case, the government will pay the holder a coupon, otherwise known as a cash payment, every six months until maturity.

The coupon rate will typically be reflected by the market rate of interest at the time of issuance. The rate will identify what the cash payment the holder will receive twice throughout the year.

At maturity, the holder will receive their final coupon payment and also receive the principal amount. The principal amount is the initial amount that was owed from the beginning.

Originally, the names of the gilts were decided based on the purpose of their issuance to minimize confusion. However, by the early 2000s, they’ve been called Treasury Gilts.

Not as popular as conventional gilts, index-linked gilts, take up approximately a quarter of the gilt market. The index-linked type of gilt issuances started in 1981. Similar to conventional gilts, they pay coupons that are set in line with market interest rates; however, their semi-annual coupons and principal payments are made to be in line with the movements of the General Index of Retail Prices (RPI).

Initially, index-linked gilts came with an eight-month indexation lag between the month of the collection of price data and the indexation of the bond. However, the indexation lag changed to three months in 2005.

 

Related Readings

CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Discount Rate
  • Floating Interest Rate
  • Treasury Bills (T-Bills)
  • Investing: A Beginner’s Guide

Corporate Finance Training

Advance your career in investment banking, private equity, FP&A, treasury, corporate development and other areas of corporate finance.

Enroll in CFI’s Finance Courses to take your career to the next level! Learn step-by-step from professional Wall Street instructors today.