The rate of return investors receive reflects the adjusted principal.
The best way to understand how TIPS work is by example. TIPS pay interest semiannually, but for the purposes of simplicity, the following looks at how the value of the bond changes in each calendar year. That year, the CPI increases by 4 percent. In Year 3, inflation drops to 2 percent. This process continues until the bond matures.
Accrued interest rate of an inflation-indexed bond
Once the bonds mature, investors receive either the adjusted, higher principal or their original investment, whichever is greater. But the principal increases with inflation, which is based on the Canadian CPI.
For example, when Canadian inflation, the CPI, was 1. The 4. At maturity, when the Canadian government will repay the principal, the principal amount will have increased as well.
Since inflation-linked bonds are not exposed to inflation, their yield is lower than normal, or nominal, bonds. The Canadian RRB has a yield of 4. CrossRef Google Scholar. Anderson, N.
Estimating and Interpreting the Yield Curve , Wiley, Google Scholar. Arak, M.
Bootle, R. Brown, R. Brynjolfsson, J.
Deacon, M. Inflation Indexed Securities , Prentice Hall, Foresi, S.
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- Inflation-Indexed Bonds and Derivatives?
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Hughston, L. Inflation Derivatives , Merrill Lynch International,