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'''Inflation-indexed bonds''' (also known as '''linkers''') are [[Bond (finance)|bonds]] where the principal is indexed to [[inflation]], and thus purports to cut out the inflation risk<ref>. Unfortunately, [[income taxes]] bring some inflation risk back to such bonds. See [[inflation tax|tax on the inflation tax]] </ref>. The first known inflation-indexed bond was issued by the [[Massachusetts Bay Company]] in [[1780]]. The market has grown dramatically since the [[United Kingdom|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.<ref>{{cite article
'''Inflation-indexed bonds''' (also known as '''inflation-linked bonds''' or colloquially as '''linkers''') are [[Bond (finance)|bonds]] where the principal is indexed to [[inflation]], and thus purports to cut out the inflation risk<ref>. Unfortunately, [[income taxes]] bring some inflation risk back to such bonds. See [[inflation tax|tax on the inflation tax]] </ref>. The first known inflation-indexed bond was issued by the [[Massachusetts Bay Company]] in [[1780]]. The market has grown dramatically since the [[United Kingdom|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.<ref>{{cite article
| last = Barclays Capital Research
| last = Barclays Capital Research
| first =
| first =

Revision as of 12:20, 21 February 2008

Inflation-indexed bonds (also known as inflation-linked bonds or colloquially as linkers) are bonds where the principal is indexed to inflation, and thus purports to cut out the inflation risk[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.

Structure

Inflation-indexed bonds pay a coupon that is equivalent to the sum of the increase in an inflation index and the real 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 coupon of an annual 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.

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 Kingdom Inflation-linked Gilt (ILG) UK Debt Management Office Retail Price Index (RPI)
France OATi and OAT€i[5] Agency France Trésor France CPI ex-tobacco (OATi), EU HICP (OAT€i)
Canada Real Return Bond (RRB)[6] 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
Greece
Italy BTP€i Department of the Treasury EU HICP
Japan JGBi Bank of Japan Japan CPI (nationwide, ex-fresh-food)
Sweden Index-linked treasury bonds Swedish National Debt Office Swedish CPI
Iceland

Inflation-indexed bond indices

Inflation-indexed bond indices include Barclays World Government Inflation-Linked Index.

References

  1. ^ . Unfortunately, income taxes bring some inflation risk back to such bonds. See tax on the inflation tax
  2. ^ Template:Cite article
  3. ^ "Real Return Bonds". Retrieved 2006-06-30. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)
  4. ^ "TIPS In Depth". Retrieved 2006-06-30. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)
  5. ^ "OAT€is AND BTAN€is". Retrieved 2006-06-30. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)
  6. ^ "Government of Canada Market Debt Instruments". Retrieved 2006-06-30. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)

See also

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.