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I am looking at the 2½% Index-linked Treasury Stock 2024 bond and I can't understand why its price is so high (£377). There is only a year left!

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    Can you quantify "too high", e.g. what do you expect as a price? Todays RPI-ratio is 3.69, and since inflation will not suddenly stop for the next year, 3.77 doesn't seem unreasonable.
    – Solarflare
    Commented Aug 25, 2023 at 23:22
  • @Solarflare price discounted value of principal and coupons. The coupon is only 2 percent and while rates are high to be used with discount it should bring it below par.
    – Medan
    Commented Sep 5, 2023 at 11:12
  • I asked this to figure out the direction an answer would have to go: do you think the price should be "100-some discount" (then the answer would need to explain how an index linked bond works, as D.Stanlay did) or do you think the price should be "373 instead of 377" (then the answer would probably require some math and market research, and also from you as "prior research", e.g. why you think its 373) or do you think the price should be "351 instead of 377" (then the answer (and your question) may need to analyze the likelihood that uk gets negative inflation during next year).
    – Solarflare
    Commented Sep 5, 2023 at 12:16
  • @Solarflare yes I see now, so the part I missed is that it is in index linked bond. I just did understand what that means so I assumed the notional is 100, and roughly 102.5 payout in 1 year. If I discounted this at the current rate it would have been less than 100. As I understand the face is not 100 and that face has been changing it is value during the lifetime from inception. I thought only coupons were index linked but in this case so as the face?
    – Medan
    Commented Sep 5, 2023 at 12:49
  • Yes, the value/payout at maturity is linked too (on 25th, it was 369, as I wrote in my comment).
    – Solarflare
    Commented Sep 5, 2023 at 13:17

1 Answer 1

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"Normal", bonds have a initial face value (the value that you get back at maturity) that is fixed, so the price quoted generally stays somewhere around that value. Bonds are also often quoted as a "percent of par" which tends to be near 100.

The face value of an index-linked security it adjusted periodically based on some index, which can be a published stock index like FTSE or some measure of prices like a Consumer Price Index. This bonds is linked to the value of the United Kingdom General Index of Retail Prices. So in one year, the face value you'd get for the bond at maturity will be X% higher than what it is today, where X is the change in that measure between now and maturity.

Sometimes these bonds are quoted as a percentage of the current face value to be comparable with other bonds; other times, they are quoted in their nominal value so that you know what you actually pay for one bond. But either way, the yield of the bond would be the same from now until maturity. Meaning, whether the bond was quoted as 100% of face value or £376.68, you'd pay £376.68 per bond (plus any accrued interest), and if the index went up 5% over the next year, at maturity you'd get £376.68 * 1.05 or 395.51, plus the 2.5% coupon (which is also calculated from the adjusted face value), for a gain of 7.5%.

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  • So is this bond quoted on a base of a current notional? I thought it will pay 100 in 1y and the 2.5 coupon but it actually pays more?
    – Medan
    Commented Sep 5, 2023 at 11:15
  • Yes the notional (what you get when it matures) will be adjusted with inflation.
    – D Stanley
    Commented Sep 5, 2023 at 13:22

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