Rates in Gilt –edged Market

Gilts, short for Gilt Edged Securities, are bonds issued by national governments with a fixed interest rate for a predetermined length of time. Often used by the Government to raise state cash when public expenditure exceeds income, they are subject to the same fluctuations in value as shares, but are commonly viewed as the safest of investments because of their Government backing and low risk.

A gilt that reaches maturity (i.e. the end of its term) will repay its capital value at the time of investment. They are therefore best suited to investors who seek a predictable fixed income with a guaranteed return. Gilt investment funds and gilts traded in the market do not offer the same guarantees.

Gilts are issued by the Treasury and in most cases the investor hands over the money and then receives a fixed rate of interest for the life of the gilt. When the gilt matures, its capital value is repaid at par value. Gilts are bought at their par value or at face value, usually £100. Their value will be affected by inflation, other types of investment available and the remainder of time left until maturity. The optimum time to purchase Gilts is when interest rates are high and are on the brink of falling. As interest rates fall, the value of the stock will rise and therefore can be sold at a profit.

The gilt market is split into three classifications, according to their redemption date or maturity, classified as:

• Shorts (less than five years)
• Mediums (five to fifteen years)
• Longs (more than fifteen years)

Undated gilts pay an ongoing low interest rate and have no redemption date. The government has the option to repay these but their low interest rate makes it unfavourable to do so.

Index linked gilts are linked to the rate of inflation, as their name might suggest, and are useful for investors who are concerned that inflation might devalue of their investment.

Thus far, there has never been a time when the Government has failed to repay a gilt, therefore they are a suitable alternative to cash in an investment portfolio. Any well-advised and diversified portfolio should have an element of fixed interest securities, depending on the investor’s position on taking risks and the current market conditions.

Gilt prices are directly connected to the level of interest rate, so as interest rates rise, gilt prices fall. This keeps them in competition with fixed rate alternatives. Long gilts tend to see more fluctuations in their prices, whereas because investors are aware that short gilts will be repaid soon, the price gradually moves closer to par value.

Gilts do not attract capital gains tax, but they are subject to income tax. Hence they will be a less attractive investment for those who pay a higher rate of income tax.

In the government securities market, interest rates are set by the government in the form of coupon rates. The yields on these securities are also influenced by the RBI through their purchase and sale operations in the market. In India, there is a captive market in the government securities as the banks are required to invest a proportion of their funds in government securities and other approved trustee securities as fixed by the statutory liquidity ratio (SLR).

Similarly, the non-bank financial institutions, provident funds, trusts etc. are also required to invest a proportion of their funds by law in the government securities. From the point of view of risk, these securities are least risky and if the return is to be positive in real terms, the yield has to be higher than the actual inflation rate in the economy. The yields are also related to the maturity period and a differential. is maintained as between the Center and States and government-guaranteed bonds. As part of reforms in gilt edged markets their rates of interest are decided through auction system.

The auctioning system of 182 days of Treasury bills was extended to Treasury bills of 364 days since April 1992. This has become an additional money market instrument between 91 day Treasury bill and dated Government security. The Discount and Finance House of India Ltd. was allowed to operate in Government securities since April 1992, in addition to their operations in Money Market instruments like Treasury bills and Commercial paper and in the interbank call market.