Examples of inflation-linked bonds in the following topics:
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- A bond selling at par has a coupon rate such that the bond is worth an amount equivalent to its original issue value or its value upon redemption at maturity.
- Corporate bonds usually have par values of $1,000 while municipal bonds generally have face values of $500.
- Federal government bonds tend to have much higher face values at $10,000.
- Par value of a bond usually does not change, except for inflation-linked bonds whose par value is adjusted by inflation rates every predetermined period of time.
- Bond price is the present value of coupon payments and the par value at maturity.
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- Floating rate notes (FRNs, floaters) have a variable coupon that is linked to a reference rate of interest, such as LIBOR or Euribor.
- Inflation linked bonds (linkers), in which the principal amount and the interest payments are indexed to inflation.
- However, as the principal amount grows, the payments increase with inflation.
- The United Kingdom was the first sovereign issuer to issue inflation linked Gilts in the 1980s.
- Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation linked bonds issued by the U.S. government.
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- In finance, a bond is an instrument of indebtedness of the bond issuer to the holders.
- Most individuals who want to own bonds do so through bond funds.
- Bonds are often liquid.
- There are also a variety of bonds to fit different needs of investors, including fixed rated bonds, floating rate bonds, zero coupon bonds, convertible bonds, and inflation linked bonds.
- A bond is an instrument of indebtedness of the bond issuer to the holders.
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- Floating rate notes (FRNs, floaters) have a variable coupon that is linked to a reference rate of interest, such as LIBOR or Euribor.
- Inflation linked bonds (linkers) are those in which the principal amount and the interest payments are indexed to inflation.
- However, as the principal amount grows, the payments increase with inflation.
- Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation linked bonds issued by the U.S. government.
- For example equity-linked notes and bonds indexed on a business indicator (income, added value) or on a country's gross domestic product (GDP).
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- When there is inflation, the value of the money borrowers pay back is less.
- This is because the inflation rate is built in to the nominal interest rate, which is the sum of the real interest rate and expected inflation.
- In general, this means that those with savings in the form of currency or bonds lose money from inflation.
- The lower purchasing power of money erodes the value of currency, and inflation reduces the real interest rate earned on bonds.
- In demographic terms, this often manifests as a transfer from older individuals, who are wealthier and tend to hold their savings in more conservative assets such as cash and bonds, to younger individuals, who have more debt and tend to hold their savings in more aggressive assets such as stocks.
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- Bonds have a fixed lifetime, usually a number of years.
- Bonds may be traded in the bond markets and are widely used as relatively safe investments in comparison to equity.
- Borrowing and repayment arrangements linked to inflation-indexed units of account are possible and are used in some countries.
- For example, the US government issues two types of inflation-indexed bonds, Treasury Inflation-Protected Securities (TIPS) and I-bonds.
- In countries with consistently high inflation, ordinary borrowings at banks may also be inflation indexed.
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- If the investors and businesses expect higher inflation in the future, then investors buy fewer bonds while businesses sell more bonds.
- Investors know the inflation would erode the value from their investment while businesses could repay the bonds with inflated dollars.
- Consequently, the demand for bonds shifts toward the left while the supply for bonds shifts rightward.
- We show the impact on the bond market in Figure 9.
- Thus, the greater inflationary expectations cause greater bonds prices and lower bond interest rates as we discount bond prices.
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- Six factors are wealth, expected returns, expected inflation, risk, liquidity, and information costs.
- Four factors are expected profits, business taxes, expected inflation, and government borrowing.
- Quantity is determinate while bond prices, and thus bond interest rates are indeterminate.
- If investors, businesses, and government expect higher inflation, then the supply for bonds increases while investors purchase fewer bonds because inflation erodes the value of their investments.
- Businesses and government supply more bonds because they can repay the bonds with cheaper dollars.
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- A government bond is a bond issued by a national government denominated in the country's domestic currency.
- Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds.
- At the secondary market, each bond will be assigned with very own bond code (ISIN code).
- Secondly, there is inflation risk, in that the principal repaid at maturity will have less purchasing power than anticipated if the inflation rate is higher than expected.
- Many governments issue inflation-indexed bonds, which protect investors against inflation risk by increasing the interest rate given to the investor as the inflation rate of the economy increases.
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- Draw a bond market with a supply and demand function.
- Draw a bond market with a supply and demand function.
- Calculate the real interest rate if the nominal interest rate equals 90% while the inflation rate is 100%.
- How would the demand and supply functions shift in the bond market if investors, governments, and businessmen expect greater inflation?
- You will prove the Fisher Equation and the impact of expected inflation on the market interest rate and the bond's price.