Inflation-Protected Bond
Quick Definition
A bond whose principal or coupon adjusts with inflation, preserving the investor's purchasing power regardless of price level changes.
What Is Inflation-Protected Bond?
Inflation-protected bonds are fixed-income securities designed to shield investors from inflation's erosion of purchasing power. The principal value of these bonds adjusts with an inflation index (typically CPI), and coupon payments are calculated on the adjusted principal, so both principal and interest grow with inflation. U.S. Treasury Inflation-Protected Securities (TIPS) are the most prominent example: a $1,000 TIPS with 2% coupon rate would have its principal adjusted to $1,030 after 3% inflation, and the coupon would be calculated on $1,030 (paying $20.60 instead of $20). At maturity, the holder receives the greater of the inflation-adjusted principal or the original face value, providing deflation protection as well. The "real yield" on TIPS represents the return above inflation. Other countries issue similar securities: UK index-linked gilts, Canadian Real Return Bonds, and French OATi. Inflation-protected bonds tend to underperform conventional bonds when actual inflation is lower than expected, and outperform when inflation exceeds expectations.
Inflation-Protected Bond Example
- 1A 10-year TIPS with 1.5% real yield and 3% annual inflation delivers ~4.5% nominal return, automatically keeping pace with rising prices
- 2During 2021-2022 inflation surge, TIPS outperformed nominal Treasuries by 10%+ as unexpected inflation boosted their principal adjustments
Related Terms
TIPS (Treasury Inflation-Protected Securities)
U.S. Treasury bonds whose principal adjusts with inflation (CPI), protecting investors from the erosion of purchasing power.
I Bond (Series I Savings Bond)
A U.S. government savings bond with inflation protection, combining a fixed rate with a variable rate that adjusts every 6 months based on CPI.
Real Yield
The return on a bond after adjusting for inflation, representing the actual increase in purchasing power for the investor.
Treasury Bond (T-Bond)
A long-term U.S. government debt security with a maturity of 20 or 30 years, paying semiannual coupon interest.
Bond
A fixed-income debt security where investors loan money to an issuer in exchange for regular interest payments and return of principal at maturity.
Yield Curve
A graphical representation of interest rates across different maturities for bonds of similar credit quality, typically U.S. Treasuries.
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