Chartered Institute of Stockbrokers (CISI) Professional Practice Exam

What element(s) of gilts do the government adjust to reflect the level of inflation?

1. Interest rates

2. Coupon and redemption amount

3. Maturity and yield

4. Principal and interest payments

The correct answer is: Coupon and redemption amount

The correct choice focuses on how the government adjusts the coupon and redemption amount of gilts in relation to inflation. Gilts, which are UK government bonds, can be indexed to inflation, meaning that both the periodic interest payments (coupons) and the final redemption amount (the principal returned at maturity) can increase based on inflationary trends. This ensures that the purchasing power of the investment remains stable over time, providing a hedge against inflation for investors. When inflation rises, the government will adjust the payments made to gilt holders so that the income received reflects the rise in prices in the economy. This adjustment mechanism is vital for maintaining investor confidence and ensuring that the returns on such bonds are not eroded by inflation. Other elements like interest rates, maturity, yield, and principal payments may be influenced by economic conditions or market dynamics but are not specifically adjusted by the government to directly counteract inflation in the manner that coupon and redemption amounts are. Therefore, the focus on adjustments to the coupon and redemption amount provides a clearer link to how inflation is managed within gilt structures.