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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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Updated June 23, 1997 by bwwebmaster
Copyright 1997, Bloomberg L.P.
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