Inflation-indexed bonds (also known as
inflation-linked bonds or colloquially as
linkers) are
bondsIn finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest and/or to repay the principal at a later date, termed maturity...
where the principal is indexed to
inflationIn economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also an erosion in the purchasing power of money – a loss of real...
. They are thus designed to cut out the inflation risk of an investment. The first known inflation-indexed bond was issued by the Massachusetts Bay Company in 1780. The market has grown dramatically since the
BritishThe United Kingdom of Great Britain and Northern Ireland is a sovereign state located off the northwestern coast of continental Europe. It is an island country, spanning an archipelago including Great Britain, the northeastern part of Ireland, and many small islands...
government began issuing inflation-linked
GiltsGilts are bonds issued by the governments of the United Kingdom, South Africa, or Ireland. The term is of British origin, and refers to the debt securities issued by the Bank of England, which had a gilt edge. Hence, they are called gilt-edged securities, or gilts for short...
in 1981.
Inflation-indexed bonds (also known as
inflation-linked bonds or colloquially as
linkers) are
bondsIn finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest and/or to repay the principal at a later date, termed maturity...
where the principal is indexed to
inflationIn economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also an erosion in the purchasing power of money – a loss of real...
. They are thus designed to cut out the inflation risk of an investment. The first known inflation-indexed bond was issued by the Massachusetts Bay Company in 1780. The market has grown dramatically since the
BritishThe United Kingdom of Great Britain and Northern Ireland is a sovereign state located off the northwestern coast of continental Europe. It is an island country, spanning an archipelago including Great Britain, the northeastern part of Ireland, and many small islands...
government began issuing inflation-linked
GiltsGilts are bonds issued by the governments of the United Kingdom, South Africa, or Ireland. The term is of British origin, and refers to the debt securities issued by the Bank of England, which had a gilt edge. Hence, they are called gilt-edged securities, or gilts for short...
in 1981. As of 2008, government-issued inflation-linked bonds comprise over $1.5 trillion of the international debt market. 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 periodic
couponThe coupon or coupon rate of a bond is the amount of interest paid per year expressed as a percentage of the face value of the bond. It is the interest rate that a bond issuer will pay to a bondholder.-Overview:...
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 equationThe Fisher equation in financial mathematics and economics estimates the relationship between nominal and real interest rates under inflation....
. A rise in coupon payments is a result of an increase in inflation expectations, real rates, or both.
For some bonds, such as the Series 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 principal of the bond changes, which results in a higher
interestInterest is a fee paid on borrowed assets. It is the price paid for the use of borrowed money, or, money earned by deposited funds. Assets that are sometimes lent with interest include money, shares, consumer goods through hire purchase, major assets such as aircraft, and even entire factories in...
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.
Global issuance
The most liquid instruments are Treasury Inflation-Protected Securities (TIPS), a type of
US Treasury securityA United States Treasury security is a government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States Federal government, and they are often referred to simply as Treasuries...
, 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.
GermanyGermany , officially the Federal Republic of Germany , is a country in Central Europe. It is bordered to the north by the North Sea, Denmark, and the Baltic Sea; to the east by Poland and the Czech Republic; to the south by Austria and Switzerland; and to the west by France, Luxembourg, Belgium,...
,
CanadaCanada is a country occupying most of northern North America, extending from the Atlantic Ocean in the east to the Pacific Ocean in the west and northward into the Arctic Ocean...
,
GreeceGreece , officially the Hellenic Republic , is a country in southeastern Europe, situated on the southern end of the Balkan Peninsula....
,
AustraliaAustralia , officially the Commonwealth of Australia, is a country in the Southern Hemisphere comprising the continental mainland , the island of Tasmania, and numerous smaller islands in the Indian and Pacific Oceans...
,
ItalyItaly , officially the Italian Republic , is a country located on the Italian Peninsula in Southern Europe and on the two largest islands in the Mediterranean Sea, Sicily and Sardinia. Italy shares its northern, Alpine boundary with France, Switzerland, Austria and Slovenia...
,
Japanis an island country in East Asia. Located in the Pacific Ocean, it lies to the east of the Sea of Japan, People's Republic of China, North Korea, South Korea and Russia, stretching from the Sea of Okhotsk in the north to the East China Sea and Taiwan in the south...
,
SwedenSweden , officially the Kingdom of Sweden , is a Nordic country on the Scandinavian Peninsula in Northern Europe...
and
IcelandThe Republic of Iceland is a European island country located in the North Atlantic Ocean. It has a population of about 320,000 and a total area of 103,000 km². Its capital and largest city is Reykjavík, whose surrounding area is home to approximately two thirds of the national population...
- as well as a number of smaller emerging markets - also issue inflation-indexed bonds.
| Country |
Issue |
Issuer |
Inflation Index |
United StatesThe United States of America is a federal constitutional republic comprising fifty states and a federal district...
|
Treasury Inflation-Protected Securities (TIPS) |
US Treasury |
US Consumer Price Index |
United StatesThe United States of America is a federal constitutional republic comprising fifty states and a federal district...
|
Series I Inflation-Indexed Savings Bonds A United States Treasury security is a government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States Federal government, and they are often referred to simply as Treasuries...
(I-Bonds) |
US Treasury |
US Consumer Price Index |
United KingdomThe United Kingdom of Great Britain and Northern Ireland is a sovereign state located off the northwestern coast of continental Europe. It is an island country, spanning an archipelago including Great Britain, the northeastern part of Ireland, and many small islands...
|
Inflation-linked Gilt Gilts are bonds issued by the governments of the United Kingdom, South Africa, or Ireland. The term is of British origin, and refers to the debt securities issued by the Bank of England, which had a gilt edge. Hence, they are called gilt-edged securities, or gilts for short...
(ILG) |
UK Debt Management Office The UK Debt Management Office , was established on 1 April 1998. The DMO is responsible for carrying out the Government's debt management policy of minimising financing costs over the long term, taking account of risk, and managing the aggregate cash needs of the Exchequer in the most...
|
Retail Price Index (RPI) |
FranceFrance , officially the French Republic , is a country located in Western Europe, with several overseas islands and territories located on other continents. Metropolitan France extends from the Mediterranean Sea to the English Channel and the North Sea, and from the Rhine to the Atlantic Ocean...
|
OAT OATs are government bonds issued by Agence France Trésor , generally by auction according to an annual calendar published in advance. These fungible securities are issued with maturities of seven to 50 years, and have become the method of choice for placing the French government’s long-term debt. ....
i and OAT€i |
Agence France Trésor |
France CPI ex-tobacco (OATi), EU HICP (OAT€i) |
CanadaCanada is a country occupying most of northern North America, extending from the Atlantic Ocean in the east to the Pacific Ocean in the west and northward into the Arctic Ocean...
|
Real Return Bond (RRB) |
Bank of CanadaThe Bank of Canada is Canada's central bank. It was created by the Bank of Canada Act of 1934, to "promote the economic and financial well-being of Canada." It is the sole issuer of banknotes in Canada, and the central bank for the Canadian dollar....
|
Canada All-Items CPI A consumer price index is a measure estimating the average price of consumer goods and services purchased by households. A consumer price index measures a price change for a constant market basket of goods and services from one period to the next within the same area...
|
AustraliaAustralia , officially the Commonwealth of Australia, is a country in the Southern Hemisphere comprising the continental mainland , the island of Tasmania, and numerous smaller islands in the Indian and Pacific Oceans...
|
Capital Indexed Bonds (CAIN series) |
Department of the Treasury (Australia) The Department of the Treasury is an Australian Government department. Its role is to focus and develop economic policy. The department is divided into four groups, Fiscal, Macroeconomic, Revenue and Markets with support coming from the Corporate Services Division...
|
Weighted Average of Eight Capital Cities: All-Groups Index |
GermanyGermany , officially the Federal Republic of Germany , is a country in Central Europe. It is bordered to the north by the North Sea, Denmark, and the Baltic Sea; to the east by Poland and the Czech Republic; to the south by Austria and Switzerland; and to the west by France, Luxembourg, Belgium,...
|
Bund index. and BO index. |
Bundesrepublik Deutschland Finanzagentur |
EU HICP ex Tobacco |
GreeceGreece , officially the Hellenic Republic , is a country in southeastern Europe, situated on the southern end of the Balkan Peninsula....
|
|
|
|
ItalyItaly , officially the Italian Republic , is a country located on the Italian Peninsula in Southern Europe and on the two largest islands in the Mediterranean Sea, Sicily and Sardinia. Italy shares its northern, Alpine boundary with France, Switzerland, Austria and Slovenia...
|
BTP€i |
Department of the Treasury |
EU HICP ex Tobacco |
Japanis an island country in East Asia. Located in the Pacific Ocean, it lies to the east of the Sea of Japan, People's Republic of China, North Korea, South Korea and Russia, stretching from the Sea of Okhotsk in the north to the East China Sea and Taiwan in the south...
|
JGBi |
Ministry of Finance (Japan) The ' is one of cabinet-level ministries of the Japanese government. The Ministry was once named Ōkura-shō . The Ministry is headed by the Minister of Finance , who is a member of the Cabinet and is typically chosen from members of the Diet by the Prime Minister.The Ministry's origin was back in...
|
Japan CPI (nationwide, ex-fresh-food) |
SwedenSweden , officially the Kingdom of Sweden , is a Nordic country on the Scandinavian Peninsula in Northern Europe...
|
Index-linked treasury bonds |
Swedish National Debt Office The Swedish National Debt Office founded by the Riksdag of the Estates in 1789, is a Government agency in Sweden...
|
Swedish CPI |
IcelandThe Republic of Iceland is a European island country located in the North Atlantic Ocean. It has a population of about 320,000 and a total area of 103,000 km². Its capital and largest city is Reykjavík, whose surrounding area is home to approximately two thirds of the national population...
|
|
|
|
Inflation-indexed bond indices
Inflation-indexed bond indices include the family of Barclays Inflation Linked Bond Indices, such as the Barclays Inflation Linked Euro Government Bond Indices, and the
Lehman BrothersLehman Brothers Holdings Inc. was a global financial-services firm which, until declaring bankruptcy in 2008, participated in business in investment banking, equity and fixed-income sales, research and trading, investment management, private equity, and private banking. It was a primary dealer...
U.S. Treasury: U.S. TIPS index.
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.