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Case Study

UK gilts: Analysis of bond investments

By Nuno Fernandes

3 pages

May 2014

Reference: IMD-7-1577

This case is about government bonds, using specific bonds issued by the UK Government. It can be used to teach the basics of time value of money and discounting cash flows. But it can also be used to delve into fundamental issues surrounding bond valuation and bond pricing methodologies, as well as to explore more general topics such as corporate financing. Finally, the case serves as an introduction to the yield curve, its role and interpretation, an understanding of the risk of investing in bonds, and a discussion on risk-free rates and sovereign risk. The case provides the opportunity to emphasize important concepts such as: (1) Time value of money; (2) Net present value (NPV) and internal rate of return (IRR); (3) Valuing bonds by discounted cash flows (DCF); (4) Difference between yield to maturity (YTM) and coupon rate; (5) Above or below par; (6) Relative attractiveness of long vs. short bond maturity and when it is most appropriate to use each type; (7) Liquidity and bond pricing; (8) Yield curve shape; (9) Sovereign bond spreads.

Learning Objective

Discounting cash flows and computing NPV
Estimating the yield to maturity for a given price and coupon rate (e.g. IRR)
Understanding the risk of investing in bonds with different maturities.

Keywords

Bond, Valuation, Net Present Value, Discounted Cash Flow, Yield Curve

Type

Published Sources

Available Languages

English

Related material

Teaching note

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