What are Gilts
Gilts are bonds that are issued by the British government, and they are generally considered low-risk investments. Gilts are the U.K. equivalent of U.S. Treasury securities, and the name originates from the original certificates, issued by the British government, which had gilded edges.
Gilts can be of two types: conventional gilts issued in nominal terms, and index-linked gilts, which are indexed to inflation and are similar to Treasury inflation-protected securities in the United States.
BREAKING DOWN Gilts
A gilt is a bond denominated in British pounds issued by HM Treasury, and payments on gilts are backed by the credit of the U.K. government. While the term "gilt" is primarily associated with the United Kingdom, India's government securities are also called gilts due to the country's history as a British colony. Bonds issued by blue-chip companies that are considered to be high-quality and low-risk investments are can be called gilt-edged securities.
While primary private purchasers of gilts are pension funds and life insurers, the ownership of gilts by the Bank of England, the U.K. central bank, increased dramatically subsequent to 2008. A private investor can buy gilts either through the primary market administered by the U.K. Debt Management Office or the secondary market accessed via a stockbroker or other authorized parties.
Conventional gilts represent the majority of U.K. government debt. They are nominal bonds that promise to pay a fixed coupon rate every six months. When a conventional gilt matures, its holder is paid the final coupon and the principal. When issued, a coupon rate of a conventional gilt typically approximates the market interest rate at the time of issuance. Conventional gilts have prescribed maturities, which are five, 10 and 30 years from the date of issuance. Sometimes, U.K. issues ultra-long conventional gilts maturing in 55 years or undated gilts, which are very rare.
Index-linked gilts represent bonds with borrowing rates and principal payments linked to changes in the inflation rate. Index-linked gilts make coupon payments every six months with one principal payment upon maturity. Coupon rates are adjusted to reflect changes in the U.K. retail prices index, a proxy for inflation. A higher inflation rate results in a higher coupon payment on index-linked gilts. For gilts issued after September 2005, coupon rates are adjusted based on the inflation rate published three months before, while securities issued before September 2005 use an eight-month indexation lag.
Separate trading or registered interest and principal securities (strips) refer to separating a gilt into two securities. They are based on cash flows from either the principal or the coupon, and they can be traded as zero-coupon gilts. The strip market started in December 1997, and strip gilts are typically of the conventional type.