Inflation-protected bonds: how the principal is restated
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Automated material · TradeAlmanac editorial deskPrepared by a language model from our stored data and checked by an editor.
An ordinary bond suffers from inflation: a fixed coupon depreciates along with the money. There is a construction that removes the problem.
The mechanism
The bond's face value is indexed to the change in the consumer price index. The coupon is a percentage of the indexed principal — so it grows with it.
At redemption the indexed principal is returned, not the original one.
Why the coupon is low
Because the protection comes from the indexation. Comparing such a bond's coupon with an ordinary bond's is an error: their income is constructed differently.
The indexation lag
Indexation is applied with a lag: the index value for a past period is used. When inflation accelerates sharply the protection arrives several months late.
The tax feature
The uplift in principal from indexation is income and it is taxable. Real protection after tax turns out somewhat weaker than the headline suggests — Tax on coupons: how it changes the choice of bond.
Who it suits
Someone who wants to protect purchasing power over a long horizon and accepts that with low inflation such a bond will underperform an ordinary one.
Related: Real return: how much actually remained and Inflation: how it is measured and why it differs from yours.
Prepared by a language model from our stored data and checked by an editor.
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