Inflation Indexed Bonds

Benchmark Index: While India doesn't have good inflation index, the CPI would be a better option from the investors perspective as the weight of household goods is more in this index Benefits& Advantages: While investor is protected from the inflation thus keeping the purchase power parity the same, he is at disadvantage if the index doesn't reflect his market basket or in the cases of deflation. Listing: Bonds can be listed on NSE, as it is an electronic one available to many easily. Pricing : While there are two ways in which these bonds can be structured which decides its pricing, Fixed the real interest rate and linking the par value to the inflation index is the best option. Let's assume A bond with 100 Rs par value If nominal interest rate is 8% and present real interest rate is 2%.The nominal rate is 6%. Inflation index at issue is 300 and present index is 400. The new nominal rate should be calculated for the increase in the inflation and par value of the bond should be increased . the coupon rate will remain same. Tax: The earnings due to the inflation adjusted par value should be Tax Exempt for the investor to realize the benefits of these bonds, else these bonds would be worse than the normal bonds. Maturity: Since the benchmark index is fixed for the duration of the bond, it is good to prefer the short term bonds(5 yrs) to the long term bonds. This is because the market basket may change drastically as the time goes, making the benchmark index irrelevant.

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