- Inflation-indexed bond
Inflation-indexed bonds (also known as inflation-linked bonds or colloquially as linkers) are bonds where the principal is indexed to
inflation. They are thus designed to cut out the inflation risk of an investment. [ Unfortunately, income taxesbring some inflation risk back to such bonds. See tax on the inflation tax ] . The first known inflation-indexed bond was issued by the Massachusetts Bay Companyin 1780. The market has grown dramatically since the British government began issuing inflation-linked Giltsin 1981. As of 2008, government-issued inflation-linked bonds comprise over $1.5 trillion of the international debt market. [cite article
last = Barclays Capital Research
title = Global Inflation-Linked Products: A User's Guide
date = 2008-02-20
accessdate = 2008-02-21 ] The inflation-linked market primarily consists of sovereign debt, with privately issued inflation-linked bonds constituting a small portion of the market.
Inflation-indexed bonds pay a periodic coupon that is equal to the product of the inflation index and the nominal coupon rate. The relationship between coupon payments, breakeven inflation and real interest rates is given by the
Fisher equation. A rise in coupon payments is a result of an increase in inflation expectations, real rates, or both.
For some bonds, such as the Series I Savings Bonds (U.S.), the interest rate is adjusted according to inflation.
For other bonds, such as in the case of
TIPS, the underlying of the bond changes, which results in a higher interestpayment when multiplied by the same rate. For example, if the annual coupon of the bond was 5% and the underlying principal of the bond was 100 units, the annual payment would be 5 units. If the inflation index increased by 10%, the principal of the bond would increase to 110 units. The coupon rate would remain at 5%, resulting in an interest payment of 110 x 5% = 5.5 units.
A special case is that of the Australian
Capital Indexed Bond, in which the interest rate is adjusted as well as the principal.
The most liquid instruments are
Treasury Inflation-Protected Securities(TIPS), a type of US Treasury security, with about $500 billion in issuance. The other important inflation-linked markets are the UK Index-linked Gilts with over $300 billion outstanding and the French OATi/OAT€i market with about $200 billion outstanding. Germany, Canada, Greece, Italy, Japan, Swedenand Iceland- as well as a number of smaller emerging markets - also issue inflation-indexed bonds; the Australiangovernment stopped issuing the Capital Indexed Bond in 2003[cite web
Also, Chile, Korea, Poland, Israel, and Mexico issue such bonds.
title = Real Return Bonds
url = http://www.bylo.org/rrbs.html
accessdate = 2006-06-30 ]
Inflation-indexed bond indices
Inflation-indexed bond indices include Barclays World Government Inflation-Linked Index.
* [http://www.treasurydirect.gov/instit/marketables/tips/tips.htm TIPS]
* [http://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds.htm U.S. Series I Savings Bonds]
* [http://dmo.gov.uk/index.aspx?page=Gilts/Indexlinked Inflation-linked Gilts]
* [http://www.aft.gouv.fr/aft_en_21/debt_management_51/products_248/oateurois_257/ French inflation-indexed bonds]
* Deacon, Mark, Andrew Derry, and Dariush Mirfendereski; "Inflation-Indexed Securities: Bonds, Swaps, and Other Derivatives" (2nd edition, 2004) Wiley Finance. ISBN 0-470-86812-0.
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