Gilt-Edged Security

Definition

A gilt-edged security, commonly referred to as a “gilt,” is a fixed-interest security or stock issued by the British government. These securities are recognized for their high safety and reliability as investment vehicles since the risk of the government defaulting on interest payments or principal repayments is very low.

Characteristics of Gilts:

• Types: Gilts can either be redeemable or irredeemable.
  • Redeemable Gilts: Classified based on their redemption period:
    • Long-Dated Gilts (Longs): Redeemable in fifteen years or more.
    • Medium-Dated Gilts (Mediums): Redeemable within five to fifteen years.
    • Short-Dated Gilts (Shorts): Redeemable within five years.
• Interest Sensitivity: Similar to other fixed-interest securities, gilts are sensitive to interest rates and inflation rates. To address inflation concerns, the government introduced index-linked gilts in the 1970s, where interest payments are tied to inflation rates.
• Denominations: Most gilts are issued in units of £100. If a gilt offers a high rate of interest compared to the prevailing rates, the market value of a £100 unit might exceed £100 temporarily, although it will only pay £100 upon redemption.

Examples

1. Long-Dated Gilts:

   • Example: A 30-year government bond issued in 2020 with a maturity date in 2050. It pays a fixed interest rate annually until it is redeemed in 2050.

2. Medium-Dated Gilts:

   • Example: A 10-year government bond issued in 2015 with a maturity date in 2025. It pays interest semi-annually.

3. Short-Dated Gilts:

   • Example: A 2-year government bond issued in 2021 with a maturity date in 2023. Investors receive interest payments quarterly.

4. Index-Linked Gilts:

   • Example: A gilt issued in 2020, with interest payments adjusted based on the Consumer Price Index (CPI), ensuring that the returns on the gilt keep pace with inflation.

Frequently Asked Questions

What makes gilts a safe investment?

Gilts are backed by the British government, making the risk of default very low. This high degree of security makes them a preferred choice for conservative investors.

How are gilts different from other bonds?

While gilts are government bonds issued by the UK government, other bonds can be issued by corporations, municipalities, or other governments. Gilts are generally considered safer but might offer lower returns compared to corporate bonds.

What are irredeemable gilts?

Irredeemable gilts do not have a fixed maturity date. They continue to pay interest indefinitely unless the issuer decides to repay the principal amount.

How can one purchase gilts?

Individuals can purchase gilts through brokers, directly from the Debt Management Office (DMO) in the UK, or via investment funds that include gilts in their portfolio.

Are gilt interest payments taxable?

Yes, the interest income from gilts is subject to income tax. However, the capital gains made on the sale of gilts are typically exempt from capital gains tax in the UK.

What is the role of the Debt Management Office (DMO) in relation to gilts?

The DMO is responsible for managing the UK government’s debt and for issuing gilts to finance government borrowing.

Can gilts be sold before their maturity dates?

Yes, gilts can be traded in the secondary market before their maturity dates. Their price may fluctuate based on interest rates, inflation rates, and other market conditions.

How does inflation impact gilts?

High inflation rates can erode the real value of the fixed interest payments from gilts. Index-linked gilts mitigate this risk by tying interest payments to an inflation index.

What is the difference between exchequer stocks and treasury stocks?

Both are types of gilts. Exchequer stocks are typically long-term government bonds, while treasury stocks can refer to a broader range of government securities.

Can international investors buy UK gilts?

Yes, international investors can buy UK gilts. However, they should consider currency exchange risks and potential tax implications in their home countries.

Related Terms

Exchequer Stocks

Long-term government securities issued in the form of bonds, typically intended to fund government spending.

Treasury Stocks

Government securities that may include various types of gilts and other debt instruments issued to fund government operations and manage public finances.

Index-Linked Gilts

A type of gilt whose interest payments are adjusted in line with inflation, protecting the investor from the erosion of purchasing power over time.

Redemption

The act of repaying the principal amount of a bond or security on its maturity date.

Online References

• UK Debt Management Office (DMO)
• Bank of England: Government Bond Market
• Investopedia: Treasury Securities
• HM Treasury: Gilt Prices and Yields

Suggested Books

• “Bonds: An Introduction to the Core Concepts” by Mark Mobius
• “Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman and Angel Serrat
• “Buying and Selling Securities in London” by Julian Freestone

Accounting Basics: “Gilt-Edged Security” Fundamentals Quiz

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