Info 1: inflation-indexed bonds definition
Info 2: how inflation-indexed bonds work
Info 3: inflation bonds vs fixed interest bond
Info 4: example of inflation bonds.
Opening information:
Inflation indexed bonds break into three words inflation, indexed, and bonds. Inflation means an increase in the money supply. Indexed means alphabet order list and bonds mean attached contract. Inflation-indexed bonds mean the attached contracts for printing money problem with interest.
So now let’s have a look at what is inflation-indexed bonds, how inflation-indexed bonds involved and work in the public market, and what is the difference between inflation bonds and fixed interest bonds, finally one brief example about inflation bonds.
Info 1: inflation-indexed bonds definition
Ms.makgi is a woman who is a bond Investor and psychiatrist who earns 400,000 dollars yearly in her services, this income is not fixed this might increase or decrease.
However, she is not interested in investing the individual equities Securities because it is highly risky, and the bond offered him high security and risk-free Investments.
Despite putting money in a place that she didn’t understand, she preferred to put the earned money on well-understood bonds which are issued by the central treasury government with protection from inflation risk.
Moreover, she purchased the bonds for 67,000 dollars with each unit worth of 1000 dollars valued by a 4 percent interest rate. After the purchased year the money inflation had increased about 9 percent.
So she received the 4 percent interest but not for 1000 dollars face value indeed for 1090 dollars. Because inflation amounts to 9 percent equal to 1000 dollars 90 dollars would be added to the face value of the $1000 bond after the purchased year of the government bond.
So issuer of the ruler’s government paid the 4 percent interest not for 1000 dollars face value but for 1090 dollars face value. Then next year Ms. Makgi’s 1090-dollar bonds faced an inflation of 6 percent.
That 1090 dollar bond with equal inflation of 6 percent of $65 turned into an 1155-dollar bond face value, so that year government had to pay the 4 percent interest not for the 1090 dollars but for the 1155-dollar face value.
This inflation protection would be continued until the Ms. Magi bond expired. Here the bonds issued with the function of inflation protection are named as inflation indexed bonds.
Let’s dive into how this inflation-indexed bond works in the public market.
Info 2: inflation-indexed bonds works
Inflation-indexed bonds don’t represent any specific object or thing, instead, they are debt instruments that are formed to pay the interest without affecting inflation.
That inflation protection is given by adding the inflation-increased amount to the face value of issued bonds each year and paying the interest rate with new obtained face value of the bond worth from the added inflation amount.
However, the interest rate could be the same every year until such bonds expire but not the interest-paying amount. Because when the equal inflation amount would be added to the face value of issued bonds.
The face value of the bonds would change every year, so the interest-paying amount based on the interest rate for different face value updates each year would lead to different payment
on interest amount at each term.
Therefore the face value of bonds and interest amount are changeable every year, but
not the interest rate of percentage.
Supposedly if your purchased bonds didn’t cover the increased inflation each year after the purchase of the bond, it wouldn’t be illustrated as an inflation-indexed bond.
Most people confuse inflation bonds and fixed-interest bonds, so let’s jump into the key difference in it anyway.
Info 3: inflation bonds vs fixed interest
Inflation bonds refer to the cover of the problem of the more money supply or printed issue as the inflation to pay the interest rate for the bondholders.
On the other side, fixed interest is the bonds which are pre-determined amounts which are not cover the risk of the inflation rate.
To make you more clear about the inflation-indexed bonds, let’s look at one brief example below.
Info 4: example of inflation bonds
Say the United States government had issued the bonds, which would expire in under 53 weeks, and Pay the 2.3 percent interest rate.
Next another kind of bond is issued by the same government with an interest rate of 2 percent. It would be mature in the 30-year bonds.
Here none of the bonds would be considered inflation-indexed bonds because bonds mention or introduce the cover of risk of inflation of money bonds that expired in under 52 weeks are T-bills and 30-year bonds treasury government bonds.