Questions & Answers

I am interested in investing in government stocks but am not au fait with the different categories. How does one distinguish between say 8.5 per cent Cap with a half-year yield of 4.679 and VR Try with a half-year yield of 5.648? It's all gobbledegook to me. Once I decide what I want to do, where does one make this kind of investment?

Mr P.McG., Sligo

Government stocks, or bonds as they are more accurately known, are a device by which the State raises money from its citizens with a promise to pay a predetermined amount of interest as well as returning the original investment by a given date.

It is not only governments that raise money in this way. Companies also can raise money through bonds.

The bonds issued by government are often called gilts, an indication of the added security that comes with lending to the State.

Apart from constituting a contract between the State and the investor, government bonds/stocks or gilts have another feature in that they are quoted on the stock exchange and can be bought and sold like equity investments.

The first important thing to note is that the name itself is not important. There is no substantive difference between, say, a 8.5 per cent TRY 1999 and a 8.5 per cent CAP 1999. The names are generally there to distinguish between two government bonds which otherwise share characteristics.

However, the figures in the bond title are relevant. The first - 8.5 per cent in this case - indicates the interest payable annually on the particular bond. There are also bonds which pay a variable rate of interest; these have not proved so popular with investors.

Interest rates can vary widely as they reflect the prevailing market view of rates at the time the government wants to borrow the money; at the moment, the outlook on rates is benign with Ireland's entry into European Economic and Monetary Union requiring interest rates here to fall into line with lower rates elsewhere in the euro zone, as it will be following the January 1st changeover.

The second figure in the title - 1999 in this instance - is the date on which the bond will be redeemed by the government through repayment of the initial capital sum to the investor. It is worth noting that some bonds have a range of redemption dates. In such cases the earlier date is the soonest point at which the government can redeem the bond and the latter figure is the last date for repayment of the loan by the government. It is the government which determines where, within these dates, repayment is made.

Apart from the absolute interest rate, government bonds also have another measurement of their value - their trading price. This is the price at which they can be bought or sold in the stock market. This value moves up or down depending on the demand for the particular bond. Demand is determined by how the market perceives the interest rates offered with the bond in relation to interest rates in the economy generally.

For instance, if you look at the business pages of The Irish Times in recent weeks, you will see that the 61/4 per cent TRY 1/4/99 bond is hovering between 100 and 101. This is the price for a notional £100 worth of that bond and indicates a low level of demand given that the bond is within six months of redemption and not likely to yield much by way of interest. In addition, the interest rate offered is not particularly attractive when measured against gains achievable with other investments such as equities and property. On the other hand the 113/4 per cent CAP 15/4/00 bond is trading at 111.60 for a notional £100 tranche, due largely to the fact that the available interest rate is higher than those available on the money markets and liable to remain so given the need for Irish interest rates to fall into line with their euro partners from January 1st, 1999.

When investing, the price of each notional £100 of the bond must be taken into account as it will affect the overall return on the the investment. Regardless of the price paid for the notional £100 stake, only £100 will be returned by the government at the end of the loan period. In calculating the advisability of proceeding, the gain or yield to redemption must be factored in, not merely in the interest yield, which is paid half-yearly.

The redemption yield is mostly of interest to those investors who intend to hold the stock until it matures. For such an investor, bonds are a risk-free investment in that one knows at the time of the investment how much it will yield. The price of the stock in the market is the more important factor for those who intend trading in the stock prior to redemption - although that price will obviously reflect the market perception of the redemption yield.

At its simplest, investing in gilts is taking a gamble on the future direction of interest rates.

In the past, in Ireland, it has proved to be a sound investment, comfortably outstripping inflation. However, it has not proved as profitable as investments in equities or property over the long term. Its upside is that it offers a guaranteed return to those who can or wish to hold the gilts until maturity. That security can be important, especially in today's uncertain equity and property markets.

Over the past 10 years, bonds have produced annual returns of 12.4 per cent against 13.4 per cent for property, 18.3 per cent on equities, 8.4 per cent on cash and an inflation rate of 2.6 per cent. In general, government bonds are divided into three categories - short, medium and long. Short-dated gilts are those with lives of up to five years, mediums are dated between five and 15 years and long gilts are those which will not mature within 15 years. The main difference is that changes in interest rates tend to have a disproportionately large affect on the price of long-dated gilts.

Government bonds, which are sold on behalf of the government by the National Treasury Management Agency, are generally bought as part of a managed fund investment, where their more stable performance is used to offset some of the volatility which can be encountered when dealing with company shares. However, it is possible to invest purely in government stocks by approaching a stockbroker, or indeed, a bank manager, although the former is the more regular route. Stockbrokers will charge a commission on buying or selling gilts, generally around 1 per cent.

One of the points worth bearing in mind, should you decide to go ahead with an investment in government bonds is that the interest payable to the investor is paid gross; it is up to the investor to sort out their own tax affairs on the income.

In last week's column on PRSI, you refer to the minimum qualifying number of contributions to be eligible for contributory old age pensions as 156 months. Can that be correct or should it read 156 weeks?

Mr P.B., Dublin

Oh dear, as if it was not difficult enough to qualify for contributory old age pensions. You are right, of course, in that it is 156 weekly contributions which is the minimum required to qualify.

Send your queries to Q&A, Business This Week, 10-15 D'Olier St, Dublin 2, or email to dcoyle@irish-times.ie.