Government Bonds

Government bonds are how the government takes loan. They are also known as gilts. They sell "bonds" which pay the owner a certain amount every year and when the bond expires, the government pays the fully amount back to the owner. This makes them very safe investments.

Coupon - The guaranteed fixed annual interest payment, normally divided into two 6-month payments.

\(\text{Yield} = \frac{\text{Annual coupon payment}}{\text{Current market price}} \times 100\%\)

If the market price of a bond increases, the yield will decrease (since it has the same coupon, but is more expensive)

A higher yield means it is more desirable.

Worked Example

50 year bond with maturity value $100 and a guaranteed yearly interest payment of £2.50. 5 years after issue the second hand price falls to £50. What is the yield before and after?

\(\text{Yield Before} = \frac{2.50}{100} \times 100\% = 2.5\%\)

\(\text{Yield After} = \frac{2.50}{50} \times 100\% = 5\%\)