All the investments tend to suffer when there is high inflation in the economy. It happens because high inflation devalues the profits, bringing down actual returns. For example, if your investment yield is 10% and the prevailing inflation rate is 6%, your net real payout is just 4% and not 10%. Hence, inflation-linked bonds are designed to extend maximum protection against continuously rising inflation. These bonds ensure the investors receive their interest payments based on inflation-adjusted principal amounts.
Read further to learn how inflation-linked bonds work and explore their interesting features.
Discover the Working Mechanism of Inflation Linked Bonds
If you are about to invest in inflation linked bonds, try understanding how they work with the help of the following example:
Suppose an investor buys inflation linked bonds at INR10,000 face value with a 7-year maturity and 3% coupon rate.
Here, in case the inflation rate is 5% during the bond issue, then the interest payment in the first year will be INR315 (10,500 x 3% coupon rate)
Here, 10,500= 10,000+5% inflation rate.
Further, let us say the inflation rate increases to 6% in the second year, then the annual interest payment will be INR 333.9 (11,130 x 3% coupon rate) in the second year.
Here, 11,1130 = 10,500+6% inflation rate.
Now, this calculation will continue until the bond is mature.
Key Features of Inflation Linked Bonds
Besides protecting investors against inflation, inflation linked bonds carry a lot of other characteristics. So, if you are investing in them, ensure you are aware of the following features:
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Diversify Your Portfolio
Inflation linked bonds provide returns taking into account prevalent inflation rates. Thus, they can help you counterbalance the risks associated with other asset categories. Including the said bonds in your portfolio thus diversifies it and paves the way for a smart risk management strategy.
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Capital Protection
The inflation linked bonds provide interest returns by adjusting the principal amounts per the inflation. It ensures that the purchasing power of your investment is maintained. Hence, even if the economy is volatile, your base capital stays protected, and you receive it back on maturity.
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Tradable Investment Option
The said bonds are easily tradable over the counter, on stock exchanges, and via Order Matching Negotiated Dealing Systems (NDS-OM). It makes them a liquid asset, enabling the investors to have an easy exit before maturity. So investors do not have to miss out on other investment opportunities.
Wrapping Up!
Also popular as real return bonds, inflation linked bonds are a strategic investment choice to safeguard your investments against inflation. They help you protect the real purchasing power of your hard-earned money. These bonds also strengthen your portfolio, especially during a rise in inflation.
Make an informed investment decision regarding inflation linked bonds with GoldenPi and take a step towards a financially secure future.
FAQs About What are Inflation Linked Bonds?
1. Are there any disadvantages associated with inflation linked bonds?
As inflation linked bonds come with inflation protection, their nominal yield is lower in comparison to non-inflation-linked bonds. Hence, such securities are less appealing to investors who are seeking investment options with higher returns.
2. Are inflation linked bonds taxable?
The interest and capital gains earned on inflation linked bonds are both taxable. However, it is better to consult a professional tax expert for details on tax computation and compliance.
3. What is the difference between inflation linked bonds and nominal bonds?
Nominal bonds are those on which investors earn fixed interest throughout the life of the bond. Their principal amount remains unchanged until maturity. Meanwhile, the interest payments and the principal amount of inflation linked bonds both keep changing with the change in inflation rate.
