Inflation Bond. Bond whose principal amount is linked to an Inflation Index. Inflation-linked bonds guarantee real returns, while nominal bonds guarantee nominal returns.
The inflation rate is used to define the factor or multiplier for the bond, that is the factor that you multiply the bond by. How this works is that you take the inflation rate when the security was issued, and the inflation rate at the present. The difference between these becomes the Factor, e.g. 100% -> 101% gives 1% so for example for a $1000 issue - calculate the principal on which the interest is paid AND the principal from the point of view of how the principal is repaid.
Some inflation bonds only do this on interest, some only on interest, but most apply it to the principal and interest. Coupon interest calculated based on the adjusted amount of the bond. so a fixed coupon rate is multiplied by e.g. 1010 in the example above. Variations e.g. Italy - daily published factor published for that bond, whereas other calculate based on underlying index.
Typically a CPI or a statistical number generated by the govt. typically a lagging three month index. See UK bonds on this. US and Japanese ones - look at inflation rate 3 months prior. Unlike an Amortizing Security this principal value of the bond is increasing, whereas for an Amortizing Security, the principal is decreasing. In Canada, these are also referred to as "real return bonds".
Additional review with OTPP May 05 2010 indicates that this is part of a classification of bonds where the principal amount itself varies according to some index, a point which was not understood at the original review session. Terms and labels revised to fit this picture.
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