Inflation-Linked Bond
A bond whose principal and interest payments adjust with an inflation index, protecting investors from purchasing power erosion.
What is Inflation-Linked Bond?
An inflation-linked bond (ILB) is a debt security whose principal amount and coupon payments are tied to an inflation index—most commonly the Consumer Price Index (CPI)—so that the real value of the investment is preserved regardless of inflation. As inflation rises, the bond's principal is adjusted upward, and coupon payments (calculated as a fixed rate on the inflation-adjusted principal) also rise. At maturity, investors receive the higher of the original or inflation-adjusted principal. The most prominent example in the U.S. is Treasury Inflation-Protected Securities (TIPS); similar instruments include UK index-linked gilts and Canadian Real Return Bonds.
Example
An investor buys a $1,000 TIPS with a 1.5% real coupon. After one year, CPI inflation is 4%. The adjusted principal becomes $1,040, and the coupon payment is 1.5% × $1,040 = $15.60—higher than the $15.00 it would have been on the original principal. Over 10 years at 3% average inflation, the principal grows to approximately $1,344, fully compensating for price level increases.
Source: U.S. Treasury — Treasury Inflation-Protected Securities