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Inflation Linked Bonds

Inflation Linked Bonds

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Published by: yukiyuriki on May 20, 2011
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Inflation-indexed bond
Inflation-indexed bonds
(also known as
inflation-linked bonds
or colloquially as
linkers
)are  bondswhere the principal is indexed toinflation. They are thus designed to cut out the inflation risk of an investment.
The first known inflation-indexed bond was issued by theMassachusetts Bay Company in 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.
Theinflation-linked market primarily consists of  sovereign bonds, with privately issued inflation- linked bonds constituting a small portion of the market.See also:inflation derivatives
Contents
o
Structure
Inflation-indexed bonds pay a periodiccouponthat is equal to the product of the inflationindex and the nominal coupon rate. The relationship between coupon payments, breakeveninflation and real interest rates is given by theFisher equation. A rise in coupon payments is aresult of an increase in inflation expectations, real rates, or both.For some bonds, such as theSeries 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 principalof 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 100units, 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.
Global issuance
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-linkedmarkets are the UK Index-linked Gilts with over $300 billion outstanding and the FrenchOATi/OAT€i market with about $200 billion outstanding.Germany, Canada, Greece,
 
Australia,Italy,Japan, Sweden and Iceland- as well as a number of smaller emerging markets - also issue inflation-indexed bonds.
CountryIssueIssuerInflation Index
Agence France Trésor France CPI ex-tobacco(OATi), EU HICP ex-tobacco(OAT€i)CanadaReal Return Bond(RRB)
Bank of CanadaCanada All-Items CPI AustraliaCapital Indexed Bonds(CAIN series)Department of theTreasury (Australia)Weighted Average of EightCapital Cities: All-GroupsIndexGermanyBund index. and BOindex.Bundesrepublik DeutschlandFinanzagentur EU HICP ex TobaccoGreeceItalyBTP€iDepartment of theTreasuryEU HICP ex TobaccoJapanJGBiMinistry of Finance(Japan)Japan CPI (nationwide, ex-fresh-food)SwedenIndex-linked treasury bondsSwedish National DebtOfficeSwedish CPIIceland
Inflation-indexed bond indices
See also:Bond market indexInflation-indexed bond indices include the family of  BarclaysInflation Linked Bond Indices
, such as the Barclays Inflation Linked Euro Government Bond Indices, and theLehman BrothersU.S. Treasury: U.S. TIPS index
.
Break-Even Inflation
If you currently own bonds, you’ve already made a bet on inflation, whether you know it or not. Traditional fixed-income investments may not provide the real return investors needduring periods of high inflation. It’s important to know whether your traditional fixed-incomeinvestment breaks-even with inflation.

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