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#examrace #inflationindexedbonds #conventionalbonds #couponrate
Inflation Indexed Bonds
With conventional bonds, investors get a fixed interest rate and receive regular interest payments, also known as coupon payments. The latter are in nominal rupees, meaning an amount that is not adjusted for inflation. The bond’s principal is returned once it reaches maturity.
The inflation risk for conventional bonds is significant, since rising inflation can erode the bond’s value over time.
Let’s say in January you purchase INR 10,000 in one-year bonds. They pay a 1.5% fixed rate per annum, and you get back your principal at maturity. At the end of the year, you will get INR 10,150, but the real value of that return depends on annual inflation.
Inflation-indexed bonds pay a fixed interest rate, offer regular coupon payments and return the principal at maturity. Here’s where they’re different: The principal is regularly adjusted for inflation, and the fixed-interest rate is applied to the adjusted principal.
The Budget has proposed introduction of bonds or National Savings Certificates whose returns will be linked to inflation. In these instruments, the principal rises with inflation, though it is still not clear whether these bonds will be linked to the consumer price index (CPI) or the more closely-watched wholesale price index (WPI). The interest, called coupon, is calculated on the adjusted (to inflation) principal. The coupon rate may or may not rise with the price index.
