Government Debt - CH2

Question 1

Who issues debt in the UK?

Answer 1

The DMO.

Question 2

How often are coupons paid on UK gilts?

Answer 2

Annually.

Question 3

Why are gilts used as a benchmark for corporate bonds?

Answer 3

Because they’re seen as credit risk free.

Question 4

How are gov’t bonds quoted?

Answer 4

On a 100 unit basis, e.g. £145 for 6% gilts 2028, £145 would be for 100 units.

Question 5

Who receives the coupon for gilts?

Answer 5

Those holding the bond cum-dividend.

Question 6

What is the Ex-dividend period?

Answer 6

7 day period where the purchaser of the bond is not entitled to the next interest payment (ownership change period).

Question 7

What is an Index-Linked Gilt?

Answer 7

Where the coupons and principal are linked to an inflation index (RPI or CPI).

Question 8

What happens to Index-Linked Gilts if there is no inflation?

Answer 8

The nominal coupon and nominal principal is paid.

Question 9

What are 3 negatives of inflation?

Answer 9

• Purchasing power falls.
• Savings eroded (if inflation > interest rate).
• Cost of living crisis.

Question 10

What is the Real Interest Rate?

Answer 10

The interest rate with inflation taken into account.

Question 11

What is the calculation for Real Interest Rate?

Answer 11

[(1 + nominal interest rate) / (1 + inflation rate)] -1

Question 12

How are bonds linked to inflation?

Answer 12

Bond prices are linked to the economic outlook, which is linked to inflation.

Question 13

What is the CPI index?

Answer 13

Calculated each month by looing at a basket of goods and services, e.g. food, travel costs, heating.

Question 14

What is the target CPI?

Answer 14

2%.

Question 15

What is the RPI index?

Answer 15

Average measure of changes in the price of goods and services.

Question 16

How often is the RPI index revised?

Answer 16

Never.

Question 17

What is a Zero Coupon Bond?

Answer 17

A bond which doesn’t offer any interest/coupon payments. Instead, the buying price/nominal of the bond is offered at a discount, then is sold at full nominal at maturity.

Question 18

What are STRIPS?

Answer 18

Stripping a bond down into it’s coupons and principal.

Question 19

What type of bond is a stripped principal?

Answer 19

A zero coupon bond, whose face value depends on the prevailing interest rate.

Question 20

What bonds can STRIPS be made out of?

Answer 20

Made out of US T-bills, or bonds the DMO says are suitable.

Question 21

What are the Pros of stripping bonds?

Answer 21

Removes reinvestment risk, and investors can precisely match liabilities of bonds.

Question 22

What is meant by ‘Reconstitution of gilts’?

Answer 22

Swapping strips for a conventional gilt.

Question 23

What are Emerging Markets?

Answer 23

Markets for developing countries (e.g. BRIC).

Question 24

What are Frontier Markets?

Answer 24

Countries with less developed markets and systems than emerging markets.

Question 25

What are the risks with investing in Frontier and Emerging markets?

Answer 25

Default risk - political and economic volatility in these countries.
Cross border risk - exchange rate fluctuations and currency devaluations.