Can anyone help explain how Nominal floating-coupon bonds protect against inflation and deflation?

CFA Level III
#1

on page 243, volume 3, exhibit 5 Nominal floating coupon bonds (coupon): Deflation unprotected, Inflation protected; (principle):Deflation protected, Inflation unprotected TIPS (coupon): Deflation unprotected, Inflation protected; (principle): Deflation protected (partial), Inflation unprotected

#2

Loosely deflation = fall in CPI inflation = increase in CPI nom floating bonds coupons are by definition inflation protected since the coupon cashflows are linked to the CPI nom floating bonds coupons are however not protected from deflation as the coupon amount you receive is negatively proportional to deflation Nom floating bonds principal are however unprotected from inflation as the principal does not increase with inflation …the principal is fixed at par Nom floating bonds principal protect from deflation as deflation increases the value of the future fixed payment does this makes sense …if so i can tackle TIPS later got to go got to go coolio means it getting too hot if faye had twins she prob have two pacs

#3

Thanks for the response. I actually think that the Nom floating bonds coupon should be deflation protected as if it is linked to the CPI, when CPI decreases, the coupon rate deceases as it is float. Thus it is coupon deflation protected. Any misunderstanding here?

#4

During deflation nominal interest rates fall . Coupon income is hit at each reset as the floating rates reduce. But the holders of the bonds realize higher prices ( i.e. principal is deflation protected, while coupon income is NOT deflation protected). Opposite is true when rates rise. Coupon income begins to rise in nominal terms as each reset gets you into higher coupon bonds. However as you hold the bond it begins to drop in value . So principal is lost , while you realize higher coupon income in subsequent resets .

#5

I got it now. Thanks all!

#6

n thanks to you for the question …

#7

janakisri Wrote: ------------------------------------------------------- > During deflation nominal interest rates fall . > Coupon income is hit at each reset as the floating > rates reduce. But the holders of the bonds realize > higher prices ( i.e. principal is deflation > protected, while coupon income is NOT deflation > protected). > > Opposite is true when rates rise. Coupon income > begins to rise in nominal terms as each reset gets > you into higher coupon bonds. However as you hold > the bond it begins to drop in value . So principal > is lost , while you realize higher coupon income > in subsequent resets . +1 for a tighter explanation with regards to inflation/deflation and principal

#8

It was my understanding that the principal of TIPS was inflation protected? Doesn’t it reset based on the CPI? Coupon RATE is the same, but since the principal is adjusted the coupon actually changes.