Hi all, In the solution, the last part there is a equation : 10250(1+i')^3 = 13041*I(1.1.05)/I(1.1.08) I am wondering why it doesn't use 6-month time lag for the inflation index? In my mind, it should be I(1.7.04)/I(1.7.07)
The time lagged index is used to get the payments received on an index-linked bond. The actual (non-time lagged) index is used to find the real return.
Hello, As I was solving this sum, I am confused what does this mean I(1.7.07)/I(1.7.02) also as there is a 6 month time lag, and as we are considering I(1.7.07) which is 6 month before the redemption date then how can we select I(1.7.02) which is 6 month after the start date given
I(1.7.07)/I(1.7.02) is the ratio of the inflation index in July 2007 to that in July 2002. It tells us the overall growth in prices between those two dates. 1.7.07 is 6 months before maturity. Note that the question tells us that the bond is issued on 1.1.03, so 1.7.02 is 6 months before the date of issue of the bond. So the 6 month lag is correctly applied.
Ok...And even if the investor purchased the $10000 nominal of bond on 1 Jan 2005, when we calculate the redemption payment, it takes 10000 * I(1.7.07)/I(1.7.02) Why don't we take 10000 * I(1.7.07)/I(1.7.04)? Regards, Warrior
In order to calculate the amount of a payment actually received from an index-linked bond, the indexation is always from the date of issue of the bond to the date of payment of the redemption amount or coupon (allowing for any time lag). So here, the bond is issued on 1 January 2003, and matures on 31 December 2007. So, allowing for the 6 month time lag, the redemption payment is: 10,000 I(1.7.07)/I(1.7.02). irrespective of when the investor purchased the bond. This is the way indexation of bonds works. You need to know the date of purchase by the investor (and purchase price) to calculate the real rate of return earned by the investor.
