Also known as Inflation Indexed, Index Linked Bonds, Linkers
An inflation protected bond has a principal linked to an Index (which measures inflation).
The coupons and principal are related to the level of the RPI (Retail Price Index)
Roughly speaking the amounts of the coupon and principal are scaled with the increase in the RPI over the period from the issue of the bond to the time of payment.
There is one slight complication in that the actual RPI level used in these calculations is set back 8 months.
Thus the base measurement is 8 months before issue and the scaling of any coupon is with respect to the increase in the RPI index from this base measurement to the level 8 months before the coupon is paid.
One of the reasons for this complexityis that the initial estimate of the RPI is usually corrected at a later date.
The principal of inflation-protected bonds is indexed to inflation)
Treasury inflation indexed securities
Provide protection against inflation
pay a fixed coupin plus an amount which is tied to a price index
the fixed coupon represents real yield
the difference between the nominal yield on a bond and the real yield on an inflation linked bond is referred to as the breakeven inflation rate
The nominal yield on these is less than conventional bonds
The main reason for issuing is to reduce funding costs, which will be reduced if inflation turns out to be lower than anticipated
Most issued by soverigns although some have been issued by quasi-public bodies and corporates
If an investor thinks that inflation over the life of an index-linked bond will be below the breakeven inflation rate, the investor will opt for the conventional bond.
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