What affects the price of conventional gilts?
When gilts are issued, they are sold at auction, and can then be sold in the open market. So the price
actually paid for the gilt will not always reflect its nominal value.
The actual price will depend on two main factors. Firstly, there’s the coupon on offer. If a gilt is offering a 5% coupon on a face value of £100 at a time when the typical bank account pays 2%, for example, then demand will be high. As a result, the price of the gilt will rise to more than £100, and the gilt yield will fall below 5%.
Then there’s the maturity date. Put simply, when investors expect interest rates to rise (perhaps in response to rising inflation), gilt prices will tend to fall and yields rise. When interest rates are expected to fall, gilt prices will tend to rise and yields fall. The closer the gilt is to its maturity date, the less affected it will be by changes in interest rate expectations.
If you trade a gilt (i.e. buy and sell it before it is redeemed), you could make a capital loss. But if you buy and hold to maturity, you should be able to work out exactly what you’ll get in nominal terms – including the coupons.
For example, say you buy a gilt with a face value of £100 and a coupon of 5%, which matures in one year. You buy it for £103. In a year’s time, you’ll have had £5 of coupon payments, and you’ll be repaid the £100 face value. So you’ve lost £3 on the purchase price, but you’ve made a £2 total return, taking into account the coupon payments.
Of course, this may or may not be an attractive return in ‘real’ terms (after inflation). But you won’t have lost money in nominal terms.
You can find the ‘yield to maturity’ (or redemption yield) – a trickier calculation, which shows your annual return taking account of reinvested coupon payments, their timing, plus the return of capital at the redemption of the bond – on various financial websites.