Inflation-indexed bonds

Inflation indexed bonds, also known as linkers, are bonds whose principal are indexed to inflation, removing inflation risks. The first known inflation indexed bond was issued by Massachusetts Bay Company in 1780. The market has grown dramatically since the UK government began issuing inflation-linked Gilts in 1981. Today, the asset class comprises $500 Billion + 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.

In finance, a bond is a debt security, where the issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon).

A common misconception about Inflation-indexed 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.

Although economists have long promoted inflation-indexed bonds as a useful tool for debt management and monetary policy, such bonds remain the exception. Against their use is the belief indexation fuels inflation through feedback on price and expectations. This view is bolstered by the experience of several countries where, partly owing to inflation, indexation became widespread beginning in the 60s and 70s. Indexation of financial markets in particular was seen as expedient to promote domestic savings. By the 80s inflation performance in a number of these nations deteriorated, in some cases to hyperinflation. Some have taken steps to reduce the scope of indexation. In recent years, another group of sovereign borrowers successfully integrated inflation indexed bonds to existing debt programs and promoted them because of their purported benefits to issuers and purchasers. Their benefits include improved social welfare, lower debt costs, easier implementation of monetary policy, enhanced monetary policy credibility, and development of domestic capital markets. Their experience supports a fundamental argument in literature that there is no connection between indexation and inflation. If inflationary biases result from indexation, they can be offset by other policies. Design considerations are key to success of indexed bond programs. Decisions must be taken about choice of index and its lag, how indexation is applied, term to maturity, and taxation. Indexed bonds, provided they are introduced in nations committed to contain inflation, offer benefits that ensure continued growth and acceptance. The decision by the USA Treasury in 97 to introduce these bonds continues the trend and may accelerate adoption of indexed bonds elsewhere.

In 1971 Milton Friedman scolded the USA for repayment in debt in dollars whose value is eroded by inflation. His prescription was to: “Let the Treasury promise to pay not $1,000 but a sum that will have the same purchasing power as $1,000 had when the security was issued. Let it pay as interest each year not a fixed number of dollars but that number adjusted for any rise in prices.” and after him, the U.S. Treasury has unveiled an “inflation-protection security.” This new security, also known as an inflation-indexed or inflation-linked bond, is designed to protect the purchasing power of an investor’s savings by indexing interest and principal payments to consumer prices. If prices go up, so, too, do dollar payments from an indexed bond. Therefore, holders of indexed bonds aren’t hurt by inflation. The Treasury started its indexed bond program in January 1997.

WHY WILL INVESTORS
BUY INDEXED BONDS?
Investors who desire predictable real cash flows can now include indexed bonds in their portfolios. The certain real return will be attractive to investors who are particularly risk averse. It will also be attractive to savers who want to protect their savings from being eroded by inflation.
For many years the Treasury opposed issuing indexed debt for two main reasons. One was concern that there would not be strong demand from investors. The second was some Treasury officials believed issuing indexed debt could increase borrowing costs by fragmenting (“balkanizing”) the overall Treasury bond market.

inflatio - the process of expansion

Flation -is when enflation and inflation are canceling eachother out.

Inde is French for India

Chicago Stock_Exchange

Electronic Communication Network

government_bond information
Other Lonympics sites