Bonds, inflation-indexed

Brynjolfsson, J., Fabozzi, F. (Eds.), 1999. Handbook of Inflation-Indexed Bonds. FSF Associates, New Hope, PA. 

Fleckenstein, M., 2012. The inflation-indexed bond puzzle. Working Paper, UCLA. 

Roll, R., 1996. US Treasury inflation-indexed bonds the design of a new security. 1. Fixed Income... 

Wrase, J.M., 1997. Inflation-indexed bonds how do they work Federal Reserve Bank of Philadelphia. 

An index-linked bond has its coupon or maturity value or sometimes both linked to a specific index. When governments issue index-linked bonds, the cash flows are linked to a price index such as consumer or commodity prices. Corporations have also issued index-linked bonds that are connected to either an inflation index or a stock market index. For example, Kredit Fuer Wiederaufbau, a special purpose bank in Denmark, issued a floating-rate note in March 2003 whose coupon rate will be linked to the Eurozone CPI (excluding tobacco) beginning in September 2004. Inflation-indexed bonds are detailed in Chapter 8. 

Inflation or purchasing power risk reflects the possibility of the erosion of the purchasing power of bond s cash flows due to inflation. Bonds whose coupon payments are fixed with long maturities are especially vulnerable to this type of risk. Floaters and inflation-indexed bonds have relatively low exposures to inflation risk. 

Callable bonds, putable bonds, mortgage-backed securities, and asset-backed securities are examples of (1). Floating-rate securities and inflation-indexed bonds are examples of (2). Convertible bonds and exchangeable bonds are examples of (3). 

It is true that the very recent history has been of low and relatively stable inflation, and if we look at the relationship between the first 30-year US Treasury Inflation-Indexed bond issued and an appropriate nominal comparator of similar date, the implied US inflation rate has ranged between a low of 1.2% and a high of 2.6%. However, inflation at those bounds would mean that US 100 paid in 30 years time... 

In April 1999 the SNDO launched two new linkers, a new 30-year bond (3104, 3.5% 2028) and a new 16-year bond (3105, 3.5% 2015). These two bonds were issued with an inflation floor, meaning that the new bonds had a similar structure to United States and French inflation-indexed bonds. The format of issuing inflation linked bonds was changed, this time moving back to bid price auctions, every three months. The reason being that this type of auction was common at the international level, allowing clearer signals of the volume on offer. The primary dealers were permitted to switch linkers directly with the SNDO on a daily basis, in order to enhance the liquidity of the market. 

Observing the trading patterns of a liquid market in inflation-indexed bonds enables analysts to draw conclusions about nominal versus real interest rates and to construct an inflation term structure. Such analysis is problematic, since conventional and indexed bonds typically differ considerably in liquidity. Nevertheless, as explained above, it is usually possible to infer market estimates of inflation expectations from the difference between the yields of the two types of bonds. 

Wojnilower, A. 1997. Inflation—Indexed Bonds Promising the Moon. New York Clipper Group. 

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