Inflation Linked Bonds

Inflation Linked Bonds, which are also known as Inflation Indexed Bonds or Linkers, are bonds in which principal amount is linked to the inflation i.e. if the inflation prevailing in the market is high, then the principal amount  to be paid to the holders of the Inflation Linked Bonds would also be high. Inflation Linked Bonds are aimed at saving the investors or owners of the bonds from the inflation risk.

Massachusetts Bay Company was the first to issue Inflation Linked Bonds in 1780. The British government first issued Inflation Linked Bonds in 1981. Like many other bonds, Inflation Linked Bonds regularly pay interest during the bond period while the principal amount is paid at the end of the maturity period. The value of the interest payment is derived at after adding the nominal coupon rate to the product of inflation index.

In some types of Inflation Linked Bonds, the direct changes are made in the interest rate depending on inflation. An increase in the interest paid to the holder or owner is directly proportional to inflation. Series I Savings bonds issued in the United States is an example of such bonds.

In other types of Inflation Linked Bonds, the principal amount paid to the investors changes with an increase in inflation indirectly increasing the interest payment too by multiplying the interest payment by the rate at which principal amount was increased. Treasury Inflation Protected Securities (TIPS) issued by the US treasury is the example of such kinds of bonds.

Most of the Inflation Linked Bonds issued in the market are sovereign bonds while the Inflation Linked Bonds issued by the private companies are very less in number.

Treasury Inflation Protected Securities and Series Inflation Indexed Savings bonds, both issued by US Treasury; Inflation Linked Gilt issued by UK Debt Management office; Reat Return bond, issued by Bank of Canada; Capital-Indexed bonds issued by Department of Treasury in Australia; JGBi issued by Swedish National Debt Office are some of the examples of Inflation Linked Bonds issued in many countries.

Inflation Linked Bonds are issued by governments or corporate. 

How Inflation Linked Bonds work?

In case of rise in inflation, the principal amount to be priced to the holder or owner of the Inflation Linked Bonds would increase. As a result, the interest paid to the investor will also increase. At the time of maturity, the increased principal amount is paid to the owner, thereby preventing from facing inflation risk. 

Advantages of Inflation Linked Bonds

  1. Inflation Linked Bonds provide protection to the investor and his investor from the risk of inflation and ensure that the investors do not get affected due to a decrease in the value of money.
  2. Inflation Linked Bonds also protects pension from any increase in inflation by adjusting the pension according to the changes in Consumer Price Index (CPI).

Disadvantages of Inflation Linked Bonds   

  1. Like many other bonds, holders or owners of Inflation Linked Bonds can also suffer the risk of default in payment by the issuer of the bonds.
  2. In case of deflation, the value of the bonds would go down when compared to other types of bonds.
  3. When compared to government bonds, Inflation Linked Bonds have shorter maturity period. As a result, they do not benefit when the bond market is on a high.

Inflation Linked Bonds are best for those investors who want to take benefit from the rising inflation.