Monday, October 25, 2010

Actual Consols

Today's macroeconomics class arrived at the point where I needed explain how bond prices and yields are inversely related.  Fortunately for us economists, the British government has issued perpetual bonds - i.e., bonds which pay a fixed amount ("coupon"*) to the holder with no end date - known as "consols," which make the concept easy to illustrate.

If one pays £100 for a consol with a coupon of £5, the yield is 5% (5/100).  If market interest rates rise to 10%, the consol would only be worth £50 (since 5/50 = 0.10).

I was asked if the consols, which were first issued in the 18th century, still exist today.  A little internet "research" confirms that, indeed, these long-ago loans to the British government are still providing the descendents of the aristocracy with the income to cruise around Kensington in Rolls-Royces.

This wikipedia entry explains briefly the history of consols. According to the UK Debt Management office, there is £177 million worth of "2.5% consolidated stock" still outstanding (there are several other issues, too).  As of today, according to a British trading website, the 2.5% consol is trading at 56.52, which means a yield of 4.4% (2.5/56.52 = 0.044).  This post at the FT Alphaville blog has a graph of consol yields going back to 1729.

Hmm... perhaps I should buy some, so that next time the question comes up, I can say, "yes, I have some."

*I'm not sure "coupon" is good terminology for consols - it comes from bonds that included coupons that the owner would physically cut off and redeem for the interest payments.  That wouldn't work with a perpetual bond.

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