I am not clear on the difference between what reading 26 calls “real rate bonds” and “inflation linked bonds”. I have searched the board, and I know I am not the first one to ask this question. A post back in February 2007 suggested that real rate bonds and inflation linked bonds are similar (thus, the terms can be used interchangeably), and that the inflation linked bonds issued by the US government are called “TIPS”. However, in light of Exhibit 5 in reading 25, I am wondering which part, coupon, principal or both, is protected against inflation. Of course, for nominal bonds, coupon and principal are not. Could it be that for real rate bonds, coupon is protected and principal is not, and for TIPS, principal is protected and coupon is not? Example 6 p. 198 mentions that “TIPS (…) provides for a fixed real coupon rate with the principal adjusted for inflation”. Now, obviously, if one is not clear on the definitions, one struggles to understand the recommendations… Thanks to anybody who could help.
For inflation linked bonds the coupon is protected, and thus, your principal is indirectly. $1000 is face value of a bond - today or 10 years from now or 20 years ago. What matters is the return on the pripcipal (aka your coupon) so as long as your coupon is indexed to inflation, then your return on your investment is protected. I’m not sure how well i explaiend that, but does it make sense?