In some countries there is a market in bonds whose return, both coupon and final redemption payment, is linked to the consumer price index. Investors’ experiences with inflation-indexed bonds differ across countries, as they were introduced at different times and, as a result, the exact design of index-linked bonds varies across the different markets. This, of course, makes the comparison of issues such as yield difficult and has in the past acted as a hindrance to arbitrageurs seeking to exploit real yield differentials. In this chapter, we will highlight the basic concepts behind the structure of indexed bonds and how this may differ from that employed in another market. Not all index-linked bonds link both coupon and maturity payments to a specified index; in some markets only the coupon payment is index linked. Generally the most liquid market available will be the government bond market in index-linked instruments.
In this chapter we present the structure and analysis of index-linked bonds, as well as related index-linked derivative products. Appendix 9.1 lists those countries that currently issue public-sector indexed securities.
There are a number of reasons why investors and issuers alike are interested in inflation-indexed bonds. Before considering these, we look at some of the factors involved in security design.
Choice of index: In principle, bonds can be indexed to any number of variables, including ...