How Inflation-Indexed Bonds Work
These instruments give investors two different payments:
INFLATION PAYMENT
Every six months, the principal is adjusted by an amount equal to the CPI,
payable only when the bond is sold or matures.
INTEREST PAYMENT
Bondholders receive a check twice a year for an amount equal to the principal
multiplied by the interest rate.
EXAMPLE
On a $1,000 bond, if the interest rate is 3% and inflation is 1% after
six months, the principal is adjusted to $1,010. The investor then receives a
semiannual interest payment of $15.15. If inflation rises to 3% by yearend, the
principal is adjusted to $1,030. The investor also receives another interest
payment of $15.45. Assuming similar inflation over 10 years, the investor will
receive $351.64 in interest payments while the principal will have risen to
$1,343.92.
DATA: BUSINESS WEEK, TREASURY DEPARTMENT
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