Gilt-edged securities

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Gilt-edged securities, also referred to as gilts, are bonds issued by the UK Government. The term is of British origin, and then referred to the debt securities issued by the Bank of England on behalf of His Majesty's Treasury, whose paper certificates had a gilt (or gilded) edge, hence the name.

Contents

In 2002, the data collected by the British Office for National Statistics revealed that about two-thirds of all UK gilts are held by insurance companies and pension funds. [1] Since 2009 large quantities of gilts have been created and repurchased by the Bank of England under its policy of quantitative easing, and in recent years overseas investors have also been attracted to gilts by their "safe haven" status.

Nomenclature

In his 2019 book about the gilt market from 1928 to 1972, William A. Allen described gilt-edged securities as "long‐duration liabilities of the UK government" that were traded on the London Stock Exchange [2] [3] : 1517 

Today, the term "gilt-edged security" or simply "gilt" is used in the United Kingdom as well as some Commonwealth nations, such as South Africa and India. However, when reference is made to "gilts", what is generally meant is UK gilts, unless otherwise specified. Colloquially, the term "gilt-edged" is sometimes used to denote high-grade securities, consequently carrying low yields, as opposed to relatively riskier, below investment-grade securities.

Gilt-edged market makers (GEMMs) are banks or securities houses registered with the Bank of England which have certain obligations, such as taking part in gilt auctions. [4]

The term "gilt account" is also a term used by the Reserve Bank of India to refer to a constituent account maintained by a custodian bank for maintenance and servicing of dematerialized government securities owned by a retail customer. [5]

History

Following the 1688 Glorious Revolution, with the founding in 1694 of the Bank of England by Royal Charter, King William III borrowed £1,200,000 from the bank's 1,268 private subscribers to bank stock in order to fund the war with France. [6] [7] This marked the inception of what became a permanent or perpetual national public debt with the Stock Exchange dealing in UK government securities. [2] : 10  The Bank of England's debt securities were published as certificates with gilded edges. [8]

The next major public debt incurred by the government was the South Sea Bubble of 1720. [8] British citizens continued to pay interest on that debt in 2014, when low interest rates led George Osborne, then the chancellor of the Exchequer to pay off the remaining loan. [8]

In 1927, then chancellor of the Exchequer, Winston Churchill issued 4% consols or securities, in part to refinance World War I National War Bonds originating from World War I. [8] In 2014, when they were to be repaid, these consols were valued at £218 million. [8]

The government sells bonds in order to raise the money it needs, like an IOU to be paid back at a future date—from five to thirty years—with interest. [9] This form of government borrowing proved successful and became a common way to fund wars and later infrastructure projects when tax revenue was not sufficient to cover their costs. [10] [11] Many of the early issues were perpetual, having no fixed maturity date. These were issued under various names but were later generally referred to as Consols.

Conventional gilts

These are the simplest form of UK government bond and make up the largest share of the gilt portfolio (75% as of October 2016). [12] A conventional gilt is a bond issued by the UK government which pays the holder a fixed cash payment (or coupon) every six months until maturity, at which point the holder receives their final coupon payment and the return of the principal.

Coupon rate

Conventional gilts are denoted by their coupon rate and maturity year, e.g. 4+1⁄4% Treasury Gilt 2055. The coupon paid on the gilt typically reflects the market rate of interest at the time of issue of the gilt, and indicates the cash payment per £100 that the holder will receive each year, split into two payments in March and September.

Gilt names

Historically, gilt names referred to their purpose of issuance, or signified how a stock had been created, such as 10+1⁄4% Conversion Stock 1999; or different names were used for different gilts simply to minimise confusion between them. In more recent times, gilts have been generally named Treasury Stocks. Since 2005–2006, all new issues of gilts have been called Treasury Gilts.

The most noticeable trends in the gilt market in recent years have been:

Index-linked gilts

These account for around a quarter of UK government debt within the gilt market. The UK was one of the first developed economies to issue index-linked bonds in 27 March 1981. Initially only tax-exempt pension funds were allowed to hold these bonds. The UK has issued around 20 index-linked bonds since then. Like conventional gilts, index-linked gilts pay coupons which are initially set in line with market interest rates. However, their semi-annual coupons and principal payment are adjusted in line with movements in the General Index of Retail Prices (RPI).

Ultra-long index-linked bonds, maturing in 2062 and 2068, were issued in October 2011 and September 2013 respectively, and a 2065 maturity is due to be issued in February 2016.

Indexation lag

As with all index-linked bonds, there are time lags between the collection of prices data, the publication of the inflation index and the indexation of the bond. From their introduction in 1981, index-linked gilts had an eight-month indexation lag (between the month of collection of prices data and the month of indexation of the bond). This was so that the amount of the next coupon was known at the start of each six-month interest accrual period. However, in 2005 the UK Debt Management Office announced that all new issues of index-linked gilts would use a three-month indexation lag, first used in the Canadian Real Return Bond market, and the majority of index-linked gilts now in issue are structured on that basis.

Double-dated gilts

In the past, the UK government issued many double-dated gilts, which had a range of maturity dates at the option of the government. The last remaining such stock was redeemed in December 2013. [13]

Green gilts

In September 2021, the UK held its inaugural "green gilt" sale, which was met with record demand. Investors placing over £100bn in bids. The UK's Debt Management Office (DMO) plans to sell £15bn of green gilts this year. The 12-year bond will mature in July 2033, and is priced at a yield of about 0.9 percent. The money raised by the bonds are earmarked for environmental spending, such as on projects including flood defences, renewable energy, or carbon capture and storage. [14]

Undated gilts

Historical undated gilts

Until late 2014 there existed eight undated gilts, which made up a very small proportion of the UK government's debt. They had no fixed maturity date. These gilts were very old: some, such as Consols, dated from the 18th century. The largest, War Loan, was issued in the early 20th century. The redemption (payout of the principal) of these bonds was at the discretion of the UK government, but because of their age, they all had low coupons, and so for a long time there was little incentive for the government to redeem them. Because the outstanding amounts were relatively very small, there was a very limited market in most of these gilts. In late 2014 and early 2015 the government gave notice that four of these gilts, including War Loan, would be redeemed in early 2015. [15] The last four remaining gilts, with coupons of 2.5% or 2.75%, were redeemed on 5 July 2015. [12]

Proposed new undated gilts

In May 2012 the UK Debt Management Office issued a consultation document which raised the possibility of issuing new undated gilts, but there was little support for this proposal. [16]

Gilt strips

Many gilts can be "stripped" into their individual cash flows, namely Interest (the periodic coupon payments) and Principal (the ultimate repayment of the investment) which can be traded separately as zero-coupon gilts, or gilt strips. For example, a ten-year gilt can be stripped to make 21 separate securities: 20 strips based on the coupons, which are entitled to just one of the half-yearly interest payments; and one strip entitled to the redemption payment at the end of the ten years. The title "Separately Traded and Registered Interest and Principal Securities" was created as a reverse acronym for "strips".

The UK gilt strip market started in December 1997. Gilts can be reconstituted from all of the individual strips. By the end of 2001, there were 11 strippable gilts in issue in the UK totalling £1,800 million.

Maturity of gilts

The maturity of gilts is defined by the UK Debt Management Office (DMO) is as follows: short, 0–7 years; medium, 7–15 years; and long, more than 15 years.

Gilts with a term to maturity of less than three years are also referred to as "ultra short", while the new gilts issued since 2005 with a term to maturity of 50 years or more have been referred to as "ultra long".

See also

Related Research Articles

In economics and finance, arbitrage is the practice of taking advantage of a difference in prices in two or more markets – striking a combination of matching deals to capitalise on the difference, the profit being the difference between the market prices at which the unit is traded. When used by academics, an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state; in simple terms, it is the possibility of a risk-free profit after transaction costs. For example, an arbitrage opportunity is present when there is the possibility to instantaneously buy something for a low price and sell it for a higher price.

<span class="mw-page-title-main">Bond (finance)</span> Instrument of indebtedness

In finance, a bond is a type of security under which the issuer (debtor) owes the holder (creditor) a debt, and is obliged – depending on the terms – to provide cash flow to the creditor. The timing and the amount of cash flow provided varies, depending on the economic value that is emphasized upon, thus giving rise to different types of bonds. The interest is usually payable at fixed intervals: semiannual, annual, and less often at other periods. Thus, a bond is a form of loan or IOU. Bonds provide the borrower with external funds to finance long-term investments or, in the case of government bonds, to finance current expenditure.

A zero-coupon bond is a bond in which the face value is repaid at the time of maturity. Unlike regular bonds, it does not make periodic interest payments or have so-called coupons, hence the term zero-coupon bond. When the bond reaches maturity, its investor receives its par value. Examples of zero-coupon bonds include US Treasury bills, US savings bonds, long-term zero-coupon bonds, and any type of coupon bond that has been stripped of its coupons. Zero coupon and deep discount bonds are terms that are used interchangeably.

<span class="mw-page-title-main">Government bond</span> Bond issued by a government

A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments, and to repay the face value on the maturity date.

In corporate finance, a debenture is a medium- to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term "debenture" originally referred to a document that either creates a debt or acknowledges it, but in some countries the term is now used interchangeably with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan bond evidencing the company's liability to pay a specified amount with interest. Although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital. Senior debentures get paid before subordinate debentures, and there are varying rates of risk and payoff for these categories.

In finance, a convertible bond, convertible note, or convertible debt is a type of bond that the holder can convert into a specified number of shares of common stock in the issuing company or cash of equal value. It is a hybrid security with debt- and equity-like features. It originated in the mid-19th century, and was used by early speculators such as Jacob Little and Daniel Drew to counter market cornering.

<span class="mw-page-title-main">United States Treasury security</span> US government debt instruments

United States Treasury securities, also called Treasuries or Treasurys, are government debt instruments issued by the United States Department of the Treasury to finance government spending in addition to taxation. Since 2012, U.S. government debt has been managed by the Bureau of the Fiscal Service, succeeding the Bureau of the Public Debt.

Fixed income refers to any type of investment under which the borrower or issuer is obliged to make payments of a fixed amount on a fixed schedule. For example, the borrower may have to pay interest at a fixed rate once a year and repay the principal amount on maturity. Fixed-income securities can be contrasted with equity securities that create no obligation to pay dividends or any other form of income. Bonds carry a level of legal protections for investors that equity securities do not: in the event of a bankruptcy, bond holders would be repaid after liquidation of assets, whereas shareholders with stock often receive nothing.

<span class="mw-page-title-main">Consol (bond)</span> Type of perpetual bond

Consols were government debt issues in the form of perpetual bonds, redeemable at the option of the government. They were issued by the Bank of England and the U.S. Government. The first British consols were issued in 1751. They have now been fully redeemed. The United States government issued consols from 1877 to 1930, which have likewise been redeemed.

The current yield, interest yield, income yield, flat yield, market yield, mark to market yield or running yield is a financial term used in reference to bonds and other fixed-interest securities such as gilts. It is the ratio of the annual interest (coupon) payment and the bond's price:

A corporate bond is a bond issued by a corporation in order to raise financing for a variety of reasons such as to ongoing operations, mergers & acquisitions, or to expand business. The term is usually applied to longer-term debt instruments, with maturity of at least one year. Corporate debt instruments with maturity shorter than one year are referred to as commercial paper.

Daily inflation-indexed bonds are bonds where the principal is indexed to inflation or deflation on a daily basis. They are thus designed to hedge the inflation risk of a bond. The first known inflation-indexed bond was issued by the Massachusetts Bay Company in 1780. The market has grown dramatically since the British government began issuing inflation-linked Gilts in 1981. As of 2019, government-issued inflation-linked bonds comprise over $3.1 trillion of the international debt market. The inflation-linked market primarily consists of sovereign bonds, with privately issued inflation-linked bonds constituting a small portion of the market.

The bond market is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the secondary market. This is usually in the form of bonds, but it may include notes, bills, and so on for public and private expenditures. The bond market has largely been dominated by the United States, which accounts for about 39% of the market. As of 2021, the size of the bond market is estimated to be at $119 trillion worldwide and $46 trillion for the US market, according to the Securities Industry and Financial Markets Association (SIFMA).

<span class="mw-page-title-main">Hybrid security</span>

Hybrid securities are a broad group of securities that combine the characteristics of the two broader groups of securities, debt and equity.

A perpetual bond, also known colloquially as a perpetual or perp, is a bond with no maturity date, therefore allowing it to be treated as equity, not as debt. Issuers pay coupons on perpetual bonds forever, and they do not have to redeem the principal. Perpetual bond cash flows are, therefore, those of a perpetuity.

A bond fund or debt fund is a fund that invests in bonds, or other debt securities. Bond funds can be contrasted with stock funds and money funds. Bond funds typically pay periodic dividends that include interest payments on the fund's underlying securities plus periodic realized capital appreciation. Bond funds typically pay higher dividends than CDs and money market accounts. Most bond funds pay out dividends more frequently than individual bonds.

An equity-linked note (ELN) is a debt instrument, usually a bond issued by a financial institution such as an investment bank or a subsidiary of a commercial bank. ELNs are liabilities of the issuer, but the final payout to the investor is based on an unrelated company's stock price, a stock index or a group of stocks or stock indices. The underlying stocks typically have large market capitalizations. Equity-linked notes are a type of structured product and are often marketed to unsophisticated retail investors.

In finance, inflation derivative refers to an over-the-counter and exchange-traded derivative that is used to transfer inflation risk from one counterparty to another. See Exotic derivatives.

A reverse convertible security or convertible security is a short-term note linked to an underlying stock. The security offers a steady stream of income due to the payment of a high coupon rate. In addition, at maturity the owner will receive either 100% of the par value or, if the stock value falls, a predetermined number of shares of the underlying stock. In the context of structured product, a reverse convertible can be linked to an equity index or a basket of indices. In such case, the capital repayment at maturity is cash settled, either 100% of principal, or less if the underlying index falls conditional on barrier is hit in the case of barrier reverse convertibles.

References

  1. ↑ OECD public debt markets: trend and recent structural changes. Organisation for Economic Co-operation and Development. 11 June 2002. ISBN   92-64-19761-3.
  2. 1 2 Allen, William A.; Allen, Bill (3 January 2019). The Bank of England and the Government Debt: Operations in the Gilt-Edged Market, 1928–1972. Cambridge University Press. pp. xiv+260. ISBN   978-1-108-49983-5.
  3. ↑ Singleton, John. "Review of 'The Bank of England and the Government Debt'". The Economic History Review. 72 (4).
  4. ↑ Choudhry, Moorad; Cross, Graham "Harry"; Harrison, Jim (2003). Gilt-Edged Market. Elsevier. p. 261. ISBN   978-0-08-047286-7.
  5. ↑ "PNB Gilts".
  6. ↑ The Bank Of England: History And Functions (PDF). nd. p. 19. Retrieved October 12, 2022.{{cite book}}: |work= ignored (help)
  7. ↑ "Index to Original Subscribers to Bank Stock 1694". Bank of England. nd. Retrieved October 12, 2022.
  8. 1 2 3 4 5 Castle, Stephen (December 27, 2014). "That Debt From 1720? Britain's Payment Is Coming". The New York Times. ISSN   0362-4331 . Retrieved October 12, 2022.
  9. ↑ Thomas, Daniel; David, Dharshini (11 October 2022). "Bank of England boss tells investors help will end in three days". BBC. Retrieved 11 October 2022.
  10. ↑ "A Brief History Of British Gilt Edged Securities". Gilts360.com. January 1, 2013.
  11. ↑ Choudry, Moorad; Cross, Graham "Harry"; Harrison, Jim (June 19, 2003). Gilt-Edged Market (Securities Institute Operations Management).
  12. 1 2 "UK Government index-linked gilts". United Kingdrom Debt Management Office. 25 March 2009. Archived from the original on 10 November 2016. Retrieved 10 October 2016.
  13. ↑ "Redemption of 12% Exchequer Stock 2013-2017 on 12 December 2013" (PDF). UK Debt Management Office. Retrieved 16 June 2016.
  14. ↑ Stubbington, Tommy (21 September 2021). "UK's debut 'green gilt' sale draws blockbuster demand". Financial Times. Retrieved 21 September 2021.
  15. ↑ "Chancellor to repay the nation's First World War debt". 3 December 2014. Archived from the original on 12 June 2017.
  16. ↑ "Super-long and perpetual gilts Response to consultation" (PDF). UK Debt Management Office. Retrieved 13 May 2020.
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