Inflation-indexed bond
Encyclopedia
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. 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. The inflation-linked market primarily consists of sovereign bonds, with privately issued inflation-linked bonds constituting a small portion of the market.
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.
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 interest
payment when multiplied by the same rate. For example, if the annual coupon of the bond were 5% and the underlying principal of the bond were 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.
, 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
, Australia
, Italy
, Japan
, Sweden
and Iceland
also issue inflation-indexed bonds, as well as a number of Emerging Markets, most prominently Brazil
.
U.S. Treasury: U.S. TIPS index.
Print
Bond (finance)
In 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 to use and/or to repay the principal at a later date, termed maturity...
where the principal is indexed to inflation
Inflation
In 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 general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
. 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 British
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
government began issuing inflation-linked Gilts
Gilts
Gilts are bonds issued by certain national governments. The term is of British origin, and originally referred 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. The term is also sometimes used in Ireland...
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 bonds, with privately issued inflation-linked bonds constituting a small portion of the market.
Structure
Inflation-indexed bonds pay a periodic couponCoupon (bond)
A coupon payment on a bond is a periodic interest payment that the bondholder receives during the time between when the bond is issued and when it matures. Coupons are normally described in terms of the coupon rate, which is calculated by adding the total amount of coupons paid per year and...
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
Fisher equation
The 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 interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
payment when multiplied by the same rate. For example, if the annual coupon of the bond were 5% and the underlying principal of the bond were 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 securityTreasury security
A United States Treasury security is 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. Germany
Germany
Germany , officially the Federal Republic of Germany , is a federal parliamentary republic in Europe. The country consists of 16 states while the capital and largest city is Berlin. Germany covers an area of 357,021 km2 and has a largely temperate seasonal climate...
, Canada
Canada
Canada is a North American country consisting of ten provinces and three territories. Located in the northern part of the continent, it extends from the Atlantic Ocean in the east to the Pacific Ocean in the west, and northward into the Arctic Ocean...
, Greece
Greece
Greece , officially the Hellenic Republic , and historically Hellas or the Republic of Greece in English, is a country in southeastern Europe....
, Australia
Australia
Australia , officially the Commonwealth of Australia, is a country in the Southern Hemisphere comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands in the Indian and Pacific Oceans. It is the world's sixth-largest country by total area...
, Italy
Italy
Italy , officially the Italian Republic languages]] under the European Charter for Regional or Minority Languages. In each of these, Italy's official name is as follows:;;;;;;;;), is a unitary parliamentary republic in South-Central Europe. To the north it borders France, Switzerland, Austria and...
, Japan
Japan
Japan is an island nation in East Asia. Located in the Pacific Ocean, it lies to the east of the Sea of Japan, 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...
, Sweden
Sweden
Sweden , officially the Kingdom of Sweden , is a Nordic country on the Scandinavian Peninsula in Northern Europe. Sweden borders with Norway and Finland and is connected to Denmark by a bridge-tunnel across the Öresund....
and Iceland
Iceland
Iceland , described as the Republic of Iceland, is a Nordic and European island country in the North Atlantic Ocean, on the Mid-Atlantic Ridge. Iceland also refers to the main island of the country, which contains almost all the population and almost all the land area. The country has a population...
also issue inflation-indexed bonds, as well as a number of Emerging Markets, most prominently Brazil
Brazil
Brazil , officially the Federative Republic of Brazil , is the largest country in South America. It is the world's fifth largest country, both by geographical area and by population with over 192 million people...
.
| Country | Issue | Issuer | Inflation Index |
|---|---|---|---|
| United States United States The 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 States United States The United States of America is a federal constitutional republic comprising fifty states and a federal district... |
Series I Inflation-Indexed Savings Bonds Treasury security A United States Treasury security is 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 - domestic retail bonds) |
US Treasury | US Consumer Price Index |
| United Kingdom United Kingdom The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages... |
Index-linked Gilt | UK Debt Management Office 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) |
| United Kingdom United Kingdom The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages... |
Index-linked Savings Certificates Index-linked Savings Certificates Index-linked Savings Certificates are inflation linked bonds from National Savings and Investments the state-owned savings bank in the United Kingdom. The bond terms are typically 2,3 or 5 years. The returns are linked to the RPI with an escalating premium on top... (domestic retail bonds) |
National Savings and Investments National Savings and Investments National Savings and Investments , formerly called the Post Office Savings Bank and National Savings, is a state-owned savings bank in the United Kingdom. It is an executive agency of the Chancellor of the Exchequer... |
Retail Price Index (RPI) |
| France France The French Republic , The French Republic , The French Republic , (commonly known as France , is a unitary semi-presidential republic in Western Europe with several overseas territories and islands located on other continents and in the Indian, Pacific, and Atlantic oceans. Metropolitan France... |
OAT Obligation assimilable du Trésor 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 Harmonised Index of Consumer Prices The Harmonised Index of Consumer Prices is an indicator of inflation and price stability for the European Central Bank . It is a consumer price index which is compiled according to a methodology that has been harmonised across EU countries. The euro area HICP is a weighted average of price... ex-tobacco (OAT€i) |
| Canada Canada Canada is a North American country consisting of ten provinces and three territories. Located in the northern part of the continent, it extends 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 Canada Bank of Canada The Bank of Canada is Canada's central bank and "lender of last resort". The Bank was created by an Act of Parliament on July 3, 1934 as a privately owned corporation. In 1938, the Bank became a Crown corporation belonging to the Government of Canada... |
Canada All-Items CPI Consumer price index A consumer price index measures changes in the price level of consumer goods and services purchased by households. The CPI, in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of... |
| Australia Australia Australia , officially the Commonwealth of Australia, is a country in the Southern Hemisphere comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands in the Indian and Pacific Oceans. It is the world's sixth-largest country by total area... |
Capital Indexed Bonds (CAIN series) | Department of the Treasury (Australia) Department of the Treasury (Australia) The Department of the Treasury is an Australian Government department. Its role is to focus and develop economic policy.-History:The Commonwealth Treasury was established in Melbourne in January 1901.... |
Weighted Average of Eight Capital Cities: All-Groups Index |
| Germany Germany Germany , officially the Federal Republic of Germany , is a federal parliamentary republic in Europe. The country consists of 16 states while the capital and largest city is Berlin. Germany covers an area of 357,021 km2 and has a largely temperate seasonal climate... |
Bund index. and BO index. | Bundesrepublik Deutschland Finanzagentur | EU HICP ex Tobacco |
| Greece Greece Greece , officially the Hellenic Republic , and historically Hellas or the Republic of Greece in English, is a country in southeastern Europe.... |
EU HICP ex Tobacco | ||
| Hong Kong Hong Kong Hong Kong is one of two Special Administrative Regions of the People's Republic of China , the other being Macau. A city-state situated on China's south coast and enclosed by the Pearl River Delta and South China Sea, it is renowned for its expansive skyline and deep natural harbour... |
iBond IBond iBond is a Hong Kong dollar retail inflation-indexed bonds issued by the Hong Kong Government. It was announced in 2011–2012 government budget of Hong Kong by John Tsang, the fourth Financial Secretary since the Hong Kong handover.... (domestic retail bonds) |
Hong Kong Government | Composite Consumer Price Index |
| Italy Italy Italy , officially the Italian Republic languages]] under the European Charter for Regional or Minority Languages. In each of these, Italy's official name is as follows:;;;;;;;;), is a unitary parliamentary republic in South-Central Europe. To the north it borders France, Switzerland, Austria and... |
BTP€i | Department of the Treasury | EU HICP ex Tobacco |
| Japan Japan Japan is an island nation in East Asia. Located in the Pacific Ocean, it lies to the east of the Sea of Japan, 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) 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) |
| Sweden Sweden Sweden , officially the Kingdom of Sweden , is a Nordic country on the Scandinavian Peninsula in Northern Europe. Sweden borders with Norway and Finland and is connected to Denmark by a bridge-tunnel across the Öresund.... |
Index-linked treasury bonds | Swedish National Debt Office Swedish National Debt Office The Swedish National Debt Office founded by the Riksdag of the Estates in 1789, is a Government agency in Sweden. The first task of the Debt office was to finance the War against Russia started by King Gustav III.... |
Swedish CPI |
| Iceland Iceland Iceland , described as the Republic of Iceland, is a Nordic and European island country in the North Atlantic Ocean, on the Mid-Atlantic Ridge. Iceland also refers to the main island of the country, which contains almost all the population and almost all the land area. The country has a 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
Lehman Brothers Holdings Inc. was a global financial services firm. Before declaring bankruptcy in 2008, Lehman was the fourth largest investment bank in the USA , doing business in investment banking, equity and fixed-income sales and trading Lehman Brothers Holdings Inc. (former NYSE ticker...
U.S. Treasury: U.S. TIPS index.
External links
- 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.
- Benaben, Brice, and Sebastien Goldenberg (ed.); Inflation Risks and Products (Dec. 2008) Riskbooks. ISBN 978 1 906348 07 6.