Government stocks, also called gilts, have a nominal or par value. With conventional stocks (the great majority of stocks) this is pounds 100. You get back pounds 100 capital when the stock matures. Prior to the maturity date you may get back more or less than pounds 100 if you sell gilts in the market, depending on the laws of supply and demand that set the market price - determined by various factors, particularly the general level of interest rates and the length of time a particular stock has to maturity.
Index-linked stocks are inflation-proofed. You get a relatively low initial "coupon" - the jargon term for the annual interest rate used to set the twice-yearly income payments. However, interest payments are increased each year in line with inflation as measured by the retail price index. The capital maturity value is also raised in line with inflation. At issue, the nominal value starts at pounds 100 like conventional gilts. And throughout the life of the stock, the nominal value is referred to as pounds 100 but in fact the eventual maturity increases each year with inflation.
The recent issue of 21/2 per cent Index-Linked Treasury Stock 2013 was a further issue of an existing stock. So, although the nominal value is still referred to as pounds 100, the actual maturity value in the year 2013 has already been increased in line with inflation and the current market value reflects this. The UK Debt Management Office, on behalf of the Government, auctioned a further pounds 450m nominal value of this stock. Everyone who bought actually paid the same price. This "striking price" was set at the lowest level of bid at which all the stock would be sold.
These competitive bids were made by gilt market-makers in the City of London. Private investors had the chance to make non-competitive bids. In a sense, they were bidding blind because they did not know the eventual price they would have to pay. They had to send in pounds 190 per stock in advance, and eventually got a refund because the price turned out to be pounds 183.20.
But why didn't the Government simply issue a brand new stock ? Some existing stocks are relatively illiquid. That means they are more difficult to buy and sell in the market because the amount of stock in issue is relatively low. Increasing the amount of an existing stock improves the liquidity, making a stock more desirable and improving its value. Liquidity is important for confidence in the gilt market, which in turn helps the Government manage its debt. To look at it another way, a brand new stock could be relatively illiquid and in an auction for a new stock, bids might have been lower and the Government could have raised less money.
If you are interested in this sort of investment you will have to act quickly. Another auction of index-linked stock is planned for 27 January 1999, with advertisements appearing only about a week before that date.
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