Index Linked Gilts Flashcards
1
Q
How is the coupon calculated for an index linked gilt? (5)
A
- take RPI value
- 3 months before the coupon date
- divide by RPI set at issue
- apply to the coupon
- divides by two/ paid half yearly
2
Q
Explain why an index linked gilt may have a negative yield to redemption (4)
A
- high demand
- expectation of rising inflation in the future
- gilt trading above par
- low coupon does not offset real loss
3
Q
Disadvantages of index linked gilts vs savings account (4)
A
- buying and selling costs
- before maturity it relies on market price
- no FSCS compensation
- possible capital loss
4
Q
List and explain risks associated with index linked gilts (10)
A
- interest rate risk
- rising interest rates would reduce the value of the bond
- reinvestment risk
- at maturity bonds with similar rates may not be available
- capital risk
- may make a loss on sale / at maturity
- legislation/ taxation risk
- changes to tax or legislation may effect the value of the bond
- deflation risk
- income payments could fall
5
Q
What is meant by modified duration? Why does one gilt have a longer modified duration than another? (4)
A
- modified duration shows sensitivity to interest rate changes
- lower coupon
- or higher purchase price
- mean it will take longer to return capital invested
6
Q
How are income and capital gains taxes on gilts ? (3)
A
- coupon is taxed as income
- basic rate tax payer has £1000 PSA
- capital gains are tax free
7
Q
Four ways BOE issue gilts to the market (4)
A
- auction
- tender
- conversion
- tap
- syndication
- repo
8
Q
Explain how a new gilt would be priced in order for the interest rate to redemption to be negative (3)
A
- issues at a price
- above PAR
- no/low coupon which does not offset capital loss
9
Q
What is the impact on current bond (say 4%) if a new bond is issued with a lower yield
A
- value increases
- redemption yield decreases
- income stays the same
