What is a Gilt?
|A Gilt can be
described as a government or quasi-government debt
instrument - an IOU. Each Gilt has a fixed redemption
rate (when the money will be repaid), interest rate and
face value (the price for which the government sold it
for in the first place.
The Gilts are sold and redeemed (by the issuing authority) at their face value - known as "par" During this period, the holder receives a fixed rate of interest (say 15%). This interest rate is sometimes called the "coupon". Obviously, Gilts are secure because they are underwritten by the government. Therefore, there is almost no risk that debt will not be repaid.
The price of a gilt is determined by the current level of interest rates. A gilt paying a fixed interest rate of 16% becomes more valuable when interest rates fall, because institutional buyers cannot get such a high interest rate in the market. They are thus prepared to pay more than the face value for that gilt.
For example, if the interest rates were at 16% when the gilt was first sold by Eskom, and subsequently declined to 15%, any Gilts paying 16% would immediately become more valuable - because of its higher rate.
The price of a gilt moves up until its effective interests rate comes into line with the current rate in the market. If you pay R1 010 000 for a gift with a face value of R1 000 000, the effective interest rate to you will be approximately 0,25 percent lower than if you had paid the face value for it. The capital value generally increases by roughly R10 000 with each 0,25 percent that interest rates fall. For this reason, gilt prices move inversely with interest-rate levels.
In the gilt market, a round lot is R1-million worth of stock at face value. In other words, the minimum quantity that can be bought or sold is R1-million worth - which puts this market way outside the range of most private investors. For this reason, the market also allows trading in gilt options for as little as R2 500.