Real rate bonds

CFA Level III
#1

Real rate bonds are another name for "inflation indexed "bonds ?

#2

Yeah.

#3

yes real return and inflation indexed or inflation protected.

#4

Yep, the coupon is the stated real yield, and the principal adjusts up or down with an inflation index like CPI or GDP deflator.

#5

…but that does not mean that the bond price will not decline if interest rates go up. Correct?

#6

if interest rates go up, the price will fall - if you take inflation as a constant so with real return bonds you really have to think what will increase first, inflation or interest rates and which will increase the most.

#7

correct, if REAL rates go up, your bond will still get killed.

#8

There’s still a supply and demand factor here. If real rates are going up to battle inflation, people will still pay a premium on TIPS for protection.

#9

ng30 Wrote: ------------------------------------------------------- > There’s still a supply and demand factor here. If > real rates are going up to battle inflation, > people will still pay a premium on TIPS for > protection. I don’t think real rates have anything to do with inflation here ng. Rate on a bond = real Rf + expected inflation If inflation is going up the principal on the TIPS will increase but the real rate isn’t changing because inflation is going up is it?

#10

I agree, the rate on the bond isn’t changing. I’m arguing the price can still increase in ilvino’s circumstance because people are paying a premium for the inflation hedge. I think that’s in the books, no?

#11

you’re correct, dubbs. The real rate won’t move up simply because inflation is increasing. Ng, you are right on with the comment about supply and demand - S&D and changes in real rates are the two key drivers of TIPS returns.

#12

ng30 Wrote: ------------------------------------------------------- > I agree, the rate on the bond isn’t changing. I’m > arguing the price can still increase in ilvino’s > circumstance because people are paying a premium > for the inflation hedge. I think that’s in the > books, no? Oh, I misunderstood. Agree with you here.

#13

Yep, in full agreement with you now ng.

#14

yay, i did something right

#15

ng30 Wrote: ------------------------------------------------------- > yay, i did something right WTH are you talking about. You do most stuff right and you finished the 08 exam in like an hour and fifteen mintues.

#16

I thought with inflation indexed bonds it was the coupon that got adjusted relative to some proxy for inflation ?

#17

C’mon, it was an hour 20. Unrelated note, a PM at work told me he’s a L3 grader this year, and brings it up now and then. I asked him a brief, generic question about something I don’t even remember, and he said he’s not supposed to talk about it. I’m well aware of what he shouldn’t talk about. Anyway, two days ago he asked me if there was a map of the curriculum, since CFAI just sent him all the books. I’m so scared to talk to him for fear of ethical breaches, I nearly ran in the stall and curled up in the fetal position.

#18

cfa09 Wrote: ------------------------------------------------------- > I thought with inflation indexed bonds it was the > coupon that got adjusted relative to some proxy > for inflation ? your interest rate stays the same, but the principal is adjusted. So same interest x higher principal = higher coupon

#19

thanks ng

#20

ng30 Wrote: ------------------------------------------------------- > cfa09 Wrote: > -------------------------------------------------- > ----- > > I thought with inflation indexed bonds it was > the > > coupon that got adjusted relative to some > proxy > > for inflation ? > > your interest rate stays the same, but the > principal is adjusted. So same interest x higher > principal = higher coupon actually, to be technically correct it is Same Coupon X Higher Principal = Higher Interest. Three components to inflation indexed returns: 1) Principal inflation adjustment 2) Coupon 3) Investor expectations of future inflation (how they trade relative to their nominal benchmark)