Analysis & Comment  > Bond of the Week

Share |
Back to 2011

Bond of the Week: 12 April 2011

War Loan drifts down towards the bottom of the range. Is it time to buy?

    

War Loan is back down at the bottom of the range again. Between 1998 and the current day, this undated gilt with its 3.5% coupon (no fixed maturity) has sat within a price range roughly bounded by 70 and 90p. Now trading at 71.25p, the bond has a running yield of 4.9%.

This is a generous yield for gilts. Very long-dated conventional gilts such as the Treasury 4% 2060 yield circa 4.3%. So why the chunky yield premium for our old friend?

Many market participants put this differential down to the poor liquidity of the War Loan. However, this is only partially true. The real reason for the yield premium is the implied call option imbedded in War Loan. Investors will factor in that the bond is callable at any time by the government. Should long term interest rates in the UK drop sharply below 3.5% (as been the case in Japan for over 15 years), the government can, and almost certainly will, call War Loan. However, holders of dated super-longs such as 4% 2060 can continue to enjoy their coupons for many years to come. Thus, a risk premium is priced into the War Loan and other undated gilts. 

So should one take a punt? Firstly, liquidity in War Loan has diminished over the years, so prospective buyers will have to make sure that they deal efficiently. Assuming that one can get in at a good price, the bond is well positioned for a medium-term trade (think months rather than days). Holders will be receiving an attractive running yield and the range-trading price action to date suggests that there is a good probability of exiting the position at a higher level in due course. Other undated gilts such as the Treasury 2.5% are also worth looking at - the lower coupon provides more gearing for the trade. Consider also that capital gains on gilts are tax free.

Mark Glowrey

Disclaimer

www.fixedincomeinvestor.co.uk is a division of Stockcube Research Ltd which is authorised and regulated by the Financial Services Authority. The research provided by Stockcube on the Website (and any other Stockcube website) is provided solely to enable investors to make their own investment decisions and does not constitute personal investment recommendations. No recommendations are made directly or indirectly by Stockcube as to the merits or suitability of any investment decision or transaction which may result directly or indirectly from having viewed the investment research on the Website or having received it by email. Investors are therefore urged to seek independent financial advice if they are in any doubt. The value of investments and the income derived from them can go down as well as up, and the investor may not get back the full amount originally invested.

Bonds, as with all investments, are subject to price volatility and in the event of a default an investor may lose some or all of his or her original investment. This site also contains references to derivatives. These are particularly high risk, high reward investment instruments and an investor may lose more than his initial margin requirement. Some foreign currency instruments are also featured and if an investor decides to acquire any investment denominated in a currency different from the his or her own,  the investor should note that changes in foreign exchange rates may have an adverse effect on the value, price and income of the investment in the base currency.

None of the services provided as a result of this agreement constitutes a personal recommendation to invest from Stockcube and no service should be construed as such.  For the avoidance of doubt, where the word “recommendation” is used elsewhere in these terms it does not refer to a personal recommendation, unless this is explicitly stated.  The investments described by or in the services are not suitable for all investors. Investors  who have any doubt about whether particular investments are suitable for them should contact an independent financial adviser.

These services do not include personal investment recommendations from Stockcube and should not be construed as such. Stockcube may, at its discretion, provide information, advice, recommendations and research to subscribers from time to time on its own initiative or advise subscribers of other services available. Stockcube will be under no obligation to provide on-going advice in relation to financial instruments covered on this website.