IIB
Inflation-indexed bonds (IIBs) are debt market securities offered by the government, and even some corporations like L&T, with a view to protect your savings from inflation. This is done so by linking the returns to the rise in prices
How it works?
The principal is adjusted on the basis of a factor called ‘Index ratio’, which is linked to either the Wholesale Price Index (WPI) or Consumer Price Index (CPI) – the two indices that measure inflation. It is the ratio of the new inflation index and the index that existed during the issue of the bond. It calculates the change in inflation, and thus rises or falls with the prices. The index ratio is multiplied with the face value of the bond to give the adjusted principal.
For example, Rs 1,000 is invested in an IIB with a coupon rate of 10%, when the inflation index is 200. Since it is the first year, the index ratio is 1. The interest comes to Rs 100. Now, the index goes up to 240 the second year. Then the index ratio goes up to 1.2 (240 divided by 200).
The adjusted principal thus becomes Rs 1,200, and the interest payment Rs 120. In the third year, inflation again rises to 360, then the index ratio goes up to 1.8. The adjusted principal becomes Rs 1,800 to give an interest of Rs 180.
