Question

There is a freshly issued 10-year inflation-linked bond with a face value of 1,000. Inflation in the coming year is 3%. What is the principal at the beginning and end of this year and the coupon this year and next year, for A) a zero-coupon inflation indexed bond? B) a bond with 5% annual coupon rate that is interest-indexed, and C) a bond with a 5% coupon rate that is capital-indexed?

Answer 1

A) a zero-coupon bond doesn't pay any in its life. zero-coupon bonds are sold at discount and paid its face value at maturity. the difference between it purchase price and face value are the coupons.

principal at the beginning of this year - 1,000

principal at the end of this year - 1,000

the coupon this year - 0

the coupon next year - 0

B) principal at the beginning of this year - 1,000

principal at the end of this year - 1,000

the coupon this year - face value*coupon rate = 1,000*5% = 50

the coupon next year - coupon this year*(1+inflation rate) = 50*(1+0.03) = 50*1.03 = 51.5‬

C) principal at the beginning of this year - 1,000

principal at the end of this year - 1,000

the coupon this year - face value*coupon rate = 1,000*5% = 50

the coupon next year - principal at the end of this year*(1+inflation rate)*coupon rate = 1,000*(1+0.03)*5% = 1,000*1.03*5% = 1,030‬*5% = 51.5‬