Explore Inflation Adjusted Bonds: Meaning, Interest Calculation, Index Used, Benefits, and Taxation. Learn how these bonds safeguard against inflation and their tax implications.
Article explains Meaning of Inflation Adjusted Bonds, Interest Calculation on Inflation Adjusted Bonds, Index used for Calculation of interest on Inflation Adjusted Bonds, Benefits of Inflation Adjusted Bonds and Taxation of Inflation Adjusted Bonds.
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Meaning of Inflation Adjusted Bonds
It is a type of bond that is designed to protect investors from the effects of inflation. The interest rate is linked to an index, such as the Consumer Price Index (CPI) and is adjusted intermittently to keep pace with inflation. This type of bond is an attractive investment to preserve the purchasing power of money over time.
Such bonds are a kind of debt security in which the face value of the bond rises with inflation and falls with deflation, as measured by an official price index. The real return on the bond is equal to the coupon rate minus the rate of inflation.
Interest Calculation on Inflation Adjusted Bonds
Coupons shall be paid midyear. The calculated coupon rate shall reimburse on an adjusted principal. The principal amount is typically indexed to inflation. It means when inflation rises principal shall rise consequently interest payments will rise and vice versa.
Index used for Calculation of interest on Inflation Adjusted Bonds
The principal and interest payments on inflation-indexed bonds are to be adjusted for changes in the consumer price index. The CPI is used as a means of the average change in prices reimbursed by consumers for a basket of goods and services. It is used to calculate the rate of inflation.
Benefits of Inflation Adjusted Bonds
1. They offer protection against inflation hence purchasing power of consumer shall remain intact overtime.
2. These bonds are tend to be less volatile as compared to others therefore it can be a good option.
But there are certain limitations of these bonds which are as follows:
1. These bonds offer very low income as compared to other securities like Equity.
2. CPI is used as measure which is not a perfect inflation metric because it does not include everything that consumers buy.
3. As covered above interest amount is linked with inflation adjusted principal hence whenever inflation increase interest amount will also increase and tax will be levy on Inflation Adjusted interest income but principal will be received at the end of maturity period as per prevailing market situation, Therefore in some cases investors have to pay tax on the phantom income that investors earned but not yet received.
Taxation of Inflation Adjusted Bonds
The tax treatment for these bonds is like any other debt instrument. Also, the capital gains are subject to a long-term capital gains tax of 20% with an indexation benefit. Furthermore, the interest is taxable at the investor’s income tax slab rate.Explore Inflation Adjusted Bonds: Meaning, Interest Calculation, Index Used, Benefits, and Taxation. Learn how these bonds safeguard against inflation and their tax implications.Explore Inflation Adjusted Bonds: Meaning, Interest Calculation, Index Used, Benefits, and Taxation. Learn how these bonds safeguard against inflation and their tax implications.
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