Introduction to Fixed Income Analytics: Relative Value Analysis, Risk Measures, and Valuation, Second Edition

CHAPTER 14

Analysis of Inflation-Protected Bonds

Sovereign governments and corporations offer bonds whose interest rate is tied to the rate of inflation. These debt instruments, referred to as inflation-linked bonds or simply linkers, have been issued by sovereign governments since 1945. The earlier issuers of linkers were the governments of Argentina, Brazil, and Israel. The modern linker is attributed to the U.K. government’s index-linked gilt issued in 1981, followed by Australia, Canada, and Sweden. The United States introduced an inflation-linked security in January 1997, calling those securities Treasury Inflation Protected Securities (TIPS). These securities, which carry the full faith and credit of the U.S. government, comprised approximately 10% of the outstanding U.S. Treasury market as of mid-2009. Shortly after the introduction of TIPS in 1997, U.S. government-related entities such as the Federal Farm Credit, Federal Home Loan Bank, Fannie Mae, and the Tennessee Valley Authority began issuing linkers.

There are different designs that can be used for linkers. The reference rate that is a proxy for the inflation rate is changes in some consumer price index (CPI). In the United Kingdom, for example, the index used is the Retail Prices Index (All Items) or RPI. In France, there are two linkers with two different indexes: the French CPI (excluding tobacco) and the Eurozone’s Harmonised Index of Consumer Prices (HICP) (excluding tobacco). In the United States, it is the ...