Chapter / Case 6
I-Bonds Adjust for Inflation
MA2N0247 Amarzaya.N
1
Table of Content
Features of
Bond.
Bond Market
Players?
How are
Bonds
traded?
Bonds Types
Debt VS
Equity
What is
Inflation &
Deflation?
Introduction
of the Case.
What is
Bond ?
Question &
Answer.
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What is Bond?

Bonds is simply a loan, but in
the form of security.

The issuer of the bond is the
borrower and investors
(bondholders) are the lenders.

Depending on the terms of the
bond, it is obliged to pay
interest (the coupon) at
predetermined intervals and to
repay the principal on the
maturing date, ending the loan.
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Features of Bonds

Bonds have number of
characteristics that play
a role in determining the
value of the bond.






Principal
Coupon
Price
Yield
Maturity
Credit Quality
TheThe
credit
rating
of abond
bond is
price
of
the
The maturity date is the date
important
toon
investors
as it:
depends
4
factors:
The
coupon
the amount
in the
futureiswhich
the
1.1. Provides
a
standardized
Market
interest
ratesbe
the bondholder
will will
receive
investor’s
principal
Yield
ofCredit
a bond
isrelative
rate of
measures
of
2.
quality
as interest
payments.
repaid.
There are
3 groups of
Principal
return
received
is
thequality
amount
from of
credit
3.
Maturity
Most
bonds
pay interest
bond
maturities:
money,
investing
the in
issuer
the
bond,
will repay
is
2.
Provides
andemand
impartial
4.
Supply
every
6
months,
but
it
is
1. Short-term(bills) <1 year
based
the
on
bondholder
pricequality
paid
at thefor
view
ofthecredit
of
for them to pay
2. possible
Medium-term(notes)
1 to
the bond
maturity
and
thebond.
coupon
the of
issue.
monthly,10quarterly
years or
payment.
3. Allows the investor to
annually.
3. Long-term(bonds)
>10
compare issues of
years
similar credit quality.
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Bond Market Players




Bond
Bond issuer
Bond investors
Bond dealers:


Primary bond market:


Intermediaries between bond issuers and investors
New bonds only, issuer-to-investor
Secondary bond market:

Previously issued bonds, investor-to-investor
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How are Bonds Traded?

Traditionally, bonds
were purchased directly
from the issuer, usually
through an auction or a
bank. Today, nearly all
bonds are purchased
electronically.
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Types of Bonds
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Types of Bonds
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Debt Instrument VS Equity

Negatives of debt
instruments compared with
equity assets is that once
issued, fixed rate debt
instruments cannot adjust
for inflation.
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What is Inflation?

Inflation:



Inflation is sustained increase in the general level of prices for
goods and services. It is measured as an annual percentage
increase.
When inflation goes up, there is a decline in the purchasing
power of money.
Deflation:

Deflation is when the general level of prices is falling. This is
the opposite of inflation.
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I-Bonds Adjust for Inflation




The US Treasury Department offers the I-bonds and first
issued in 1998.
I-bond is an inflation-adjusted savings bond.
Like all federal debt instruments, interest earnings are exempt
from state and local income taxes.
I-bonds issued in denominations of $50 through $10,000.
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I-Bonds Adjust for Inflation


A series I-bond earns interest through the application of a
composite rate.
The composite rate consists of :
The I-bond’s
composite rate will
be higher than its
fixed rate if the
semiannual
inflation rate
reflects any
inflation.
Likewise I-bond’s
composite rate will
be lower than its
fixed rate if the
semiannual
inflation rate
reflects any
deflation.
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Question

What effect do you think the inflation-adjusted interest rate has
on the cost of an I-bond in comparison with similar bonds with
no allowance for inflation?
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Answer
Regular Bond

Consider a regular bond of $1,000
that offers a coupon rate of 5
percent. Each year, the
bondholder would receive an
income of $50 on the bond. At
maturity, the bondholder would
get back the $1,000 principal.
I-Bond

Consider an inflation bond of
$1,000 that offers a coupon rate of
3 percent. In the first year, the
bondholder would receive an
income of $30. Assuming a 2
percent inflation rate, the value of
the bond’s principal would rise to
$1,020 in the second year, and the
bondholder would receive an
income of $30.60 in that year.
This $30.60 reflects the 2-percent
inflation adjustment.
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For your
attention
TIP
Bonds should be considered only for long-term investments.
Investments in government bonds are very low risk, stable
investments. If the investment goal is to invest long term with steady
income, bond investment is a good option.
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