Inflation-indexed bond
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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.[1]. The first known inflation-indexed bond was issued by the Massachusetts Bay Company in 1780. The market has grown dramatically since the British government began issuing inflation-linked Gilts in 1981. As of 2008, government-issued inflation-linked bonds comprise over $1.5 trillion of the international debt market.[2] The inflation-linked market primarily consists of sovereign debt, with privately issued inflation-linked bonds constituting a small portion of the market.
- See also: inflation derivatives
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[edit] Structure
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.
A common misconception about these bonds is that the interest rate changes with inflation. What actually happens is that the underlying principal of the bond changes, which results in a higher interest payment 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. The only known exception to this is the Australian Capital Indexed Bond, in which the interest rate is adjusted as well as the principal.
[edit] 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-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, Sweden and Iceland - as well as a number of smaller emerging markets - also issue inflation-indexed bonds; the Australian government stopped issuing the Capital Indexed Bond in 2003[3]
| Country | Issue | Issuer | Inflation Index |
|---|---|---|---|
| United States | Treasury Inflation-Protected Securities (TIPS)[4] | US Treasury | US Consumer Price Index |
| United States | Series I Inflation-Indexed Savings Bonds (I-Bonds)[5] | US Treasury | US Consumer Price Index |
| United Kingdom | Inflation-linked Gilt (ILG) | UK Debt Management Office | Retail Price Index (RPI) |
| France | OATi and OAT€i[6] | Agence France Trésor | France CPI ex-tobacco (OATi), EU HICP (OAT€i) |
| Canada | Real Return Bond (RRB)[7] | Bank of Canada | Canada All-Items CPI |
| Australia | Capital Indexed Bonds | Reserve Bank of Australia | Weighted Average of Eight Capital Cities: All-Groups Index |
| Germany | Bund index. and BO index. | Bundesrepublik Deutschland Finanzagentur | EU HICP ex Tabacco |
| Greece | |||
| Italy | BTP€i | Department of the Treasury | EU HICP ex Tabacco |
| Japan | JGBi | Ministry of Finance (Japan) | Japan CPI (nationwide, ex-fresh-food) |
| Sweden | Index-linked treasury bonds | Swedish National Debt Office | Swedish CPI |
| Iceland |
[edit] Inflation-indexed bond indices
- See also: Bond market index
Inflation-indexed bond indices include Barclays World Government Inflation-Linked Index.
[edit] References
- ^ Unfortunately, income taxes bring some inflation risk back to such bonds. See tax on the inflation tax
- ^ Barclays Capital Research. "Global Inflation-Linked Products: A User's Guide", 2008-02-20. Retrieved on 2008-02-21.
- ^ Real Return Bonds. Retrieved on 2006-06-30.
- ^ TIPS In Depth. Retrieved on 2006-06-30.
- ^ Series I Savings Bonds. Retrieved on 2008-04-09.
- ^ OAT€is AND BTAN€is. Retrieved on 2006-06-30.
- ^ Government of Canada Market Debt Instruments. Retrieved on 2006-06-30.
[edit] See also
[edit] External links
- TIPS
- U.S. Series I Savings Bonds
- Inflation-linked Gilts
- French inflation-indexed bonds
- Treasury Inflation Protected Securities - The Basics
[edit] Print
- 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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