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total return on an index-linked bond

J

JRB1304

Member
R(t) = gross yield on irredeemable index linked gilt at end of year t
Q(t) = cumulative inflation index at end of year t

The question asks for the total return on an equity between t and t+1, and the answer shows the return on the bond and adjusts the variables to make sense of the aforementioned situation.

Return on bond = R(t)[1/R(t+1) +1]×Q(t+1)/Q(t)

The ratio of the inflation index makes sense to me, but I can't see what the R(t)[1/R(t+1) +1] is doing.

Can anyone explain this?

Many thanks.
 
It's just a way to express the total return on an index-linked bond in terms of R(t) and Q(t).
You can get a similar expression for the total return on an equity and then divide one by the other to get the equity risk premium.

I'm not really sure why any of it was ever in the notes, sorry(!) but it's gone now, so don't worry about it :)

John
 
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