InflationProtected

Inflation-protected instruments are financial assets designed to preserve purchasing power in the face of rising prices. They adjust either the principal or the income stream in line with an inflation index, most commonly the consumer price index (CPI).

In the United States, the best-known example is Treasury Inflation-Protected Securities (TIPS). Their principal is adjusted periodically according to CPI, and interest is paid on the adjusted principal. At maturity, investors receive the greater of the original principal or the inflation-adjusted principal, guaranteeing a minimum return in real terms.

Other markets offer inflation-indexed bonds as well, such as UK index-linked gilts where both coupon and redemption are linked to CPI, and euro area inflation-linked bonds. Corporate or sovereign inflation-linked bonds exist but are less common and vary in structure.

Benefits and limitations: Inflation-protected securities help maintain purchasing power and reduce real-interest-rate risk, with relatively low credit risk for sovereign issues. However, they are not immune to deflation risk, and their real return depends on the inflation index used and market expectations of future inflation. Tax treatment may involve taxes on inflation adjustments even when the principal is not sold, and market prices can be sensitive to shifts in real yields and inflation expectations.

Investors use these instruments to match long-term liabilities, hedge portfolios against inflation, or secure a baseline real return. They are usually suited for risk-averse investors with a longer time horizon, and should be evaluated in the context of overall asset allocation.