Current Affairs 2023
Inflation indexed bonds are government-issued securities in India that protect investors from inflation. Adjusted for changes in the Consumer Price Index, these bonds preserve the purchasing power of capital and offer a secure hedge against inflation.
Jun 19, 2023
4 min read
Inflation is a silent enemy that slowly erodes the purchasing power of our hard-earned money. As prices rise, the value of our savings diminishes, leaving us with less to spend. However, there is a way to safeguard your wealth against the detrimental effects of inflation: through inflation indexed bonds.
Introduced in India in 1997, inflation indexed bonds are government-issued bonds that are index-linked, meaning their principal and interest payments are adjusted for inflation. These bonds are backed by the full faith and credit of the government, providing investors with a sense of security.
The primary purpose of these bonds is to act as a hedge against inflation. By linking their interest rates to an index such as the Consumer Price Index (CPI), these bonds ensure that investors' capital maintains its purchasing power over time. It's no wonder that they have become increasingly popular among investors seeking to protect their wealth from inflation's corrosive effects.
So, how exactly do inflation indexed bonds work? These bonds are a type of debt security in which the face value rises with inflation and falls with deflation, as measured by an official price index. The real return on these bonds is calculated as the coupon rate minus the rate of inflation.
The value of an inflation indexed bond is determined by adding the face value to the product of the change in the index since issuance and a constant called the gearing ratio, which is generally close to one. This mechanism ensures that the bond's value adjusts in accordance with inflation, preserving the investor's purchasing power.
One of the key features of these bonds is that the coupons, or interest payments, are paid semi-annually. The calculated coupon rate reimburses the investor on an adjusted principal, keeping pace with inflation. This feature makes these bonds particularly attractive for income investors.
Moreover, the Indian government has set certain investment limits for these bonds. The minimum individual investment is Rs 5000, while the maximum is Rs 10 lakh per year. Institutional investors can invest a maximum of Rs 25 lakh per year. These limits aim to safeguard the economy, especially for the benefit of the poor and middle classes.
Investing in inflation indexed bonds is relatively straightforward. They can be purchased through various channels, including the government website, banks, and brokerages. Inflation Indexed National Saving Securities - Cumulative and Index Funds-ETFs are two common ways to invest in these bonds in India. The government offers these bonds as a means for savers to protect their money from the ravages of inflation.
Before deciding to invest, it's important to weigh the pros and cons of these bonds. On the positive side, they provide protection against inflation, ensuring that your money retains its purchasing power. Additionally, they offer lower interest rates compared to other types of bonds, making them attractive for income-oriented investors. Furthermore, inflation indexed bonds tend to be less volatile than other investments, adding stability to your portfolio.
However, there are some drawbacks to consider. The interest rates on these bonds are calculated based on the change in the consumer price index, not the actual rate of inflation. This means they may have less earning potential compared to other securities. Moreover, the Consumer Price Index might not accurately reflect the true cost of living, making it an imperfect measure of inflation. Lastly, these bonds can create phantom income, as the interest payments may increase due to inflation while the bond's value fails to keep pace.
In conclusion, inflation indexed bonds can be a valuable addition to your investment portfolio, especially if you're concerned about preserving your wealth in the face of inflation. They provide a secure and government-guaranteed investment option that keeps pace with inflation, offering a low-risk way to grow your money over time. By carefully considering the pros and cons and
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