Hi, I am a little bit confused with calculation of the actual coupons on the index-linked bonds: For instance, past exam September 2006 (q.11). -On 1 July 2002, the government of a country issued an index-linked bond of term seven years. Coupons are paid half-yearly in arrears on 1 January and 1 July each year. The annual nominal coupon is 2%. Interest and capital payments are indexed by reference to the value of an inflation index with a time lag of eight months. Date Inflation index November 2001: 110.0 May 2002: 112.3 November 2002: 113.2 May 2003: 113.8 I understand that to find the actual amount of coupon say for 31/12/2003 we need to multiply coupon=1 by ‘Index May 2003’ and divide by ‘Index November 2001’. What I don’t understand is why the coupon should be multiplied by 0.8. The official solution is: 0.8×1× (Index May 2003/Index November 2001)= 0.8×1×113.8/110 However, here is a similar question from April 2004 (q.7). A government issued a number of index-linked bonds on 1 June 2000 which were redeemed on 1 June 2002. Each bond had a nominal coupon rate of 3% per annum, payable half yearly in arrears, and a nominal redemption price of 100. The actual coupon and redemption payments were indexed according to the increase in the retail price index between 6 months before the bond issue date and 6 months before the coupon or redemption payment dates. The values of the retail price index in the relevant months were: Date Retail price index December 1999: 100 June 2000: 102 December 2000: 107 June 2001: 111 December 2001: 113 June 2002: 118. In the solution provided the coupon at 1 December 2000 is 1.530 (ie. 1.5×(Index June 2000/Index December 1999), I mean it is not multiplied by any other number, in contrary to the previous example. My concern and questions then are: 1) If and when we need to multiple the coupon by another number? 2) What is the meaning of 0.8 in the first example, how to interpret it? How it is derived? I mean if it is 8 months ×0.1, then where this 0.1 comes from? Hope someone can clarify. Thank you.
I see now, it was so simple Now when I look at your explanation I cannot understand how I could miss tax issue involved. I see that I need to read the problems more carefully in order not to miss any information and don't make silly mistakes. Thanks a lot! you saved a day for me...
I am not following this example well. I am not able to understand the v/(1+r) factor. The first coupon payment that the investor receives is on 31st dec 2003. Whereas the increment in the indexation has been effective since May 2003 per annum. So is 1 year being considered as may 2003 to may 2004? How is the real present value being calculated? Can someone explain the whole example in detail? Thanks, Bijal
