Inflation-indexed bond

Inflation-indexed bonds (also known 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 2006, the asset class comprises over $1 trillion of the international debt market. The 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 a bond was 5%, and the underlying principal of the bond was 100 units, the bond would pay 5 |- units, assuming annual payments. If the inflation index then increased by 10%, the principal of the bond would then increase to 110 units. This is multiplied by the same coupon rate of 5%, which results in an interest payment of 5.5 units. The only known exception to this is the Australian Capital Indexed Bond, which also adjusts the interest rate.

Global issuance

The most liquid instruments are Treasury Inflation-Protected Securities (TIPS), a type of US Treasury security, with over $350 billion in issuance. The other important inflation-linked markets are the UK Index-linked Gilts with over $250 billion outstanding and the French OATi/OAT€i market with about $150 billion outstanding. France, Germany, Canada, Greece, Italy, Japan, Sweden and Iceland also issue inflation-indexed bonds; the Australian government stopped issuing the Capital Indexed Bond in 2003^[2]

Country	Issue	Issuer	Inflation Index
United States	Treasury Inflation-Protected Securities (TIPS)^[3]	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^[4]	Agency France Trésor	France CPI ex-tobacco (OATi), EU HICP (OAT€i)
Canada	Real Return Bond (RRB)^[5]	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

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

External links

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.

[1] . Unfortunately, income taxes bring some inflation risk back to such bonds. See tax on the inflation tax

[2] "Real Return Bonds". Retrieved 2006-06-30. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)

[3] "TIPS In Depth". Retrieved 2006-06-30. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)

[4] "OAT€is AND BTAN€is". Retrieved 2006-06-30. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)

[5] "Government of Canada Market Debt Instruments". Retrieved 2006-06-30. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)

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