What are government bonds?
Government bonds are known as gilts in the UK and are an investment vehicle that provides a fixed rate of return until their expiry. Gilts are a loan from the bondholder to the government. The issuing government pays a fixed interest rate to the investor until the bond reaches its maturity date. When the maturity date is reached, the government pays the bondholder the face value of the bond.
Government bonds pay a steady income from the gilt's coupon rate (the fixed payment of interest) to the investor. They also provide insight into the market sentiment for the issuing country, as interest rates, inflation rates and currency strength all impact bond prices.
Why does the government sell bonds?
Government bonds are sold in order to raise money for government spending, whether this be for infrastructure or daily community projects. In the UK, gilts are used to help with future developments for pensions and life insurance markets.
Types of gilts
Bonds may seem somewhat confusing on the surface, as they are referred to in different terms across countries. From bunds in Germany to OATs in France, gilts in the United Kingdom to treasuries in the US. However, they work in a similar way regardless of their name or country of origin. The most common types of bonds available in the UK include the following:
Conventional gilts. Gilts are the most common form of bond available in the UK. As above, a standard gilt issued by the UK government pays a fixed coupon yield every 6 months until the gilt’s maturity date. At this point, the gilt holder receives their final coupon payment and the capital invested.
Index-linked gilts. Index-linked gilts differ from conventional gilts. Instead of paying a fixed coupon rate, the rate is variable and based on the UK’s primary measure of inflation, the Retail Price Index (RPI). This type of gilt is specifically aimed to shelter your capital against inflation.
