Information and education only. Every page, figure and calculator on this site exists to explain how financial instruments work. Nothing here is investment, tax or legal advice, a recommendation, or a valuation you can rely on. Full disclaimer

Fixed Income

Inflation-Linked Bond

Also known as: TIPS, Linkers, ILB

A bond that grows with the price level — real purchasing power, contractually guaranteed.

3 min read · 567 words

1 · SnapshotThe one idea to remember
Key intuition: nominal bonds fix the number on the cheque; linkers fix what the cheque can buy.
2 · BeginnerWhat is it, really?

An ordinary bond promises fixed currency amounts; inflation decides what they're worth. An inflation-linked bond promises fixed purchasing power: its principal is scaled up with a consumer price index, and coupons are paid on that growing principal.

Own a linker through years of 5% inflation and both your principal and coupons ratchet up ~5% per year; a conventional bondholder just quietly loses. The linker's quoted "real yield" is the return you earn above inflation, whatever inflation turns out to be.

The most famous versions are US TIPS, UK index-linked gilts, and euro-area linkers (Bunds/OATs indexed to euro HICP). Most guarantee at least original principal back at maturity even after deflation.

Asset class
Fixed income (real rates)
Instrument type
Index-linked sovereign bond
Traded
OTC dealer market
Typical users
Pensions, endowments, inflation hedgers
3 · IntermediateHow it works in practice

Mechanics

  • Index ratio: principal × (CPI now / CPI at issue), applied with a ~2–3 month lag.
  • Cash flows: real coupon × indexed principal each period; indexed principal (floored at par for most issuers) at maturity.
  • Quotes: in real yield and real (unindexed) price; settlement multiplies by the index ratio.

Breakeven inflation — the market's forecast

Compare a 10-year nominal yield (say 4.0%) with the 10-year real yield on a linker (say 1.6%): the difference, 2.4% breakeven, is the average inflation at which both bonds return the same. Buy linkers if you expect inflation above breakeven; nominals if below. Breakevens are among the most-watched inflation expectation gauges anywhere.

What linkers hedge — and what they don't

They hedge realised CPI inflation over the holding period to maturity. They do not shield you from real-rate risk: if real yields rise, linker prices fall like any bond's (2022: US real yields jumped ~250bp and long TIPS lost heavily even as inflation ran hot).

Worked example: 10-year linker, 1% real coupon, bought at par. Inflation runs 4%/year for a decade → final principal ≈ 148, coupons growing from 1.0 to ~1.47/year. Total nominal return ≈ 5%/yr; real return: the promised 1%.
4 · AdvancedPricing & valuation

Pricing: real cash flows on a real curve

Value indexed flows by discounting real amounts at real zero rates \(\rho_t\), or equivalently nominal expected flows at nominal rates — Fisher links the curves:

$$ (1 + y_{nom}) = (1 + y_{real})(1 + \pi^e)(1 + \text{IRP}) $$
What the symbols mean
  • ythe yield to maturity
  • nhow many periods, or how many things
  • rthe interest rate, per year
  • pia probability, or a profit, depending on the line above

where \(\pi^e\) is expected inflation and IRP the inflation risk premium. Breakeven = \(\pi^e\) + IRP − liquidity premium on the linker: unpacking those three is a research industry.

Convexity and the lag

The indexation lag makes the last months of a linker effectively nominal, and seasonality in CPI (unadjusted indices) creates predictable price patterns that carry traders arbitrage. The deflation floor is an embedded put on the price index, valued with inflation option models (year-on-year vs. zero-coupon inflation caps/floors).

Inflation derivatives connection

Zero-coupon inflation swaps quote fixed \(K\) against realised index growth: pays \(\big[\tfrac{I_T}{I_0} - (1+K)^T\big]\). Swap breakevens vs. bond breakevens define the linker asset-swap basis — a barometer of balance-sheet and liquidity conditions in the linker market.

$$ \text{Real DV01 hedging: } \Delta P \approx -D_{real}\,\Delta y_{real} \;+\; \text{BE duration}\,\Delta \pi^{BE} $$
What the symbols mean
  • Deltahow much a derivative moves when the underlying moves
  • Pa price, or a present value
  • Dduration: how far a bond's cash flows sit in the future
  • rthe interest rate, per year
  • ythe yield to maturity
  • pia probability, or a profit, depending on the line above

Linker books are hedged on the two axes separately: real-rate risk with linkers/futures, breakeven risk with inflation swaps or nominal-linker pairs.

The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.

5 · Desk notesHow practitioners think about it
Practitioner note: a linker is a real-rate instrument first and an inflation hedge second — over short horizons real-yield moves dominate P&L; only held to maturity does the pure inflation hedge assert itself.

Read next

Plain. Fixed IncomeTreasury · Bund · Gilt · Sovereign

Government Bond

A loan to a state, and the reference price of money itself — the yardstick every other asset is measured against.
Plain. Fixed IncomeCredit · IG / HY bonds

Corporate Bond

Lending to companies for a spread: the extra yield is the price of the chance they don't pay you back.
Needs a footing. Fixed IncomeZero · Strip · Discount bond

Zero-Coupon Bond

No coupons, one payment: buy at a discount, collect face value at maturity. The purest interest-rate instrument.
Needs a footing. Fixed IncomeFRN · Floater

Floating Rate Note

A bond whose coupon resets with the market — interest-rate risk engineered out, credit risk left in.

Where this instrument shows up elsewhere

  • InflationStart hereConceptsThe only loss that requires no market move, arrives every year, and never appears on a statement
  • Why is my money worth less even though it grew?Start hereQuestionsTwo numbers are moving
  • The Yield CurveSome background helpsConceptsOne line, drawn from overnight to 30 years — the bond market's forecast, the economy's mood ring, and a P&L engine…