Can somebody please explain the difference here?
- Nominal bonds payments are not indexed to inflation
- Real rate bonds payments are indexed to inflation
So if Nominal rate = real rate + inf
and i receive nominal payments then surely im receiving inflation rate included in my payment and it seems right that i would say they are indexed. what does ‘indexed to inflation’ actually mean here. getting confused thanks
Nominal is priced with EXPECTED INFLATION. Say we think inflation is going to be 3%…and it ends up 5%. We are only getting compensated for 3%. The cash flows DO NOT CHANGE on a nominal fixed bond. Now with TIPS (real), if CPI was up to 5%, we would get 5%. Nominal will outperform Real when inflation is less than expected (all else equal). Real will outperform Nominal when Inflation (and CPI) > expected inflation, all equal