Section 2 - Fixed income securities - characteristics Flashcards
(36 cards)
what is a gilt?
Gilts are a UK government sterling bond
how is a conventional Gilt denoted?
by its coupon rate and maturity (e.g. Treasury stock 8% 2020)
key features of a Gilt?
- holder is paid a fixed cash payment every six months until maturity
- at maturity the final coupon is paid and the return of the principal
- prices of conventional gilts are quoted in terms of £100 nominal
- specific maturity date
features of index-linked gilts
- • Protect investors against the erosive effects of inflation
• Both coupons and redemption value linked to the retail price index (RPI)
• Three-month indexation lag if issued after Sept 2005 prior to this was an 8 month lag
how are gilts categorised in terms of maturity
BASIC
categorised according to their remaining respective maturities. Long for more than 15 years; medium for 7-15 years and short for less than 7 years. ultra-short for under 3 years.
MORE SPECIFIC
o Undated (perpetual) e.g. war loan, 2 ½ consols (all finally redeemed 5th July 15) o Double dated, last issue matured – Treasury 12% 2013/2017 – four year callable issue when the government can call the redeeming in – is a period of time not an or option.
what does stripping a gilt refer to?
breaking it down to its individual cash flows, which can be traded separately as zero-coupon gilts.
how many cash flows would a three year gilt have?
7
6 semi-annual coupon payments
one principal repayment
characteristics of a gilt strip
- Cash flows separately traded
- Manufactured zero coupon bond
- Registered interest = coupons Principal = nominal value
- Computer shares investor services handle the Gilt register
how are gilt prices quoted?
clean
what is a clean price
price excluding accrued interest - so that reported price changes reflect changes in market conditions and not changes in accrued interest
thus makes it easier to compare bond prices where the bond pays coupons on different dates
what is the dirty price
when the gilt is purchased, the actual price paid is known as the dirty price which is the clean price plus any accrued interest.
This is because the seller of the bond will have earned some fraction of the coupon, but will not receive it from the DMO since they are selling the bond prior to the next coupon date. It is therefore rilled into the actual price paid for the bond.
what is the ex-dividend date?
7 days (or less) before the payment of the next coupon and the investor is not entitled to that coupon payment
when a gilt is quoted cum-dividend the investor is entitled to the next coupon
what index do UK index linked bonds use?
retail price index
what index do US index linked bonds use?
Consumer price index (CPI)
what do index linked gilts aim to offer investors? and explain how
a fixed real return ie. a return above and over the prevailing rate of inflation.
The nominal payments from other gilts are reduced in real terms by inflation. However, ILGs have both their coupon and redemption values linked to the PRI.
As overall retail/ consumer prices rise so do the nominal income streams from ILGs.
The timing of the uplift to the coupon and principle payments usually refers to a recent past value of the chosen price index e.g. lag og three months
hypothesis of the real fisher effect
there will be a real interest rate for each economy (currency) and that if investors can choose which currency to invest in without restriction, the real interest rate will be the same everywhere.
In such a world if interest rates were not equal then arbitrageurs would act in such a way as to eliminate any differences
standard settlement of a Gilt
Standard settlement of T+1
what is bond indenture?
• Legal document outlining the rights of the bondholders, obligations of the issuer and characteristics of the issue for example:
o Sinking funds: proportion of the bond redeemed each year
o Protective covenants: limitations on future actions
o Call/ put provisions: early redemption features
what is a sinking fund provision
requires that a firm ‘retires’ (buys back) a certain proportion fo the bond issue throughout the life of the bond each year.
This is seen as an advantage to the remaining bondholders, since it reduces the final amount that the firm has to pay when the issue finally matures
What is a protective covenant
specifies the limitations on the future actions of the issuing firm. These are design to ensure that the stream of income required to meet coupon and principal payments from the bond is not exposed to undue risk.
give e.g.’s of items a covenant might place limitations on
- the proportion of earnings that can be paid to shareholders
- the amount of additional debt that can be raised by the company
- the ranking of any future debt
- the amount that company execs pay themselves
what does a call provision on a corporate bond allow?
Usually allows the firm to redeem the issue at its discretion on pre-specified dates at pre-determined prices.
when may a firm use a call provision on a corporate bond
if interest rates fall retiring the issue that pays a higher yield and issuing new debt at a lower rate
who do call provisions only serve to benefit
the firm issuing the bond
