Treasury inflation bonds are securities that are designed to protect an investor from the long-term effects of inflation. The principal amount of a treasury inflation bond increases or decreases in direct proportion to the rate of inflation, but never falls below the original purchase price. These bonds are officially known as Treasury Inflation-Protected Securities and are issued by the U.S. Department of the Treasury to both individual and corporate investors. Treasury inflation bonds are issued in 5, 10, or 30 year terms and pay a fixed rate of interest twice each year. These inflation-protected bonds can be purchased through stockbrokers, banking institutions, or directly from the U.S. Treasury.
The U.S. Department of the Treasury began issuing treasury inflation bonds in 1997. The U.S. government guarantees this bond in the same manner as any other U.S. Treasury security. Although these bonds have a fixed interest rate, the actual amount of interest may vary from one period to the next because the interest is always applied to the adjusted principal. If inflation occurs during the term of this type of bond, the principal value will increase. In the event of deflation, the inflation-increased principal value of the bond will decrease accordingly. When treasury inflation bonds reach maturity, the owner is either paid the original face value of the security, or the higher inflation-adjusted amount.
Treasury inflation bonds protect investors from the effects of inflation by increasing the principal value of the bond as the inflation rate increases. Inflation generally occurs when the overall level of the cost of goods or services increases over a particular time period. As overall prices increase, the value of a currency will decrease. Inflation has occurred when a currency will no longer buy as many goods or services as it would during a previous corresponding time period. The annual percentage of change in overall prices is usually referred to as the inflation rate.
The principal amount of treasury inflation bonds rises or falls according to a system of measurement known as the consumer price index. In the U.S., the consumer price index is considered to be one of the most important factors used to measure the economy. This index is used to measure inflation by observing changes in the average cost of products and services purchased by consumers. The consumer price index is the only measurement used by the U.S Treasury to adjust the principal amount of treasury inflation bonds. The U.S Treasury provides bondholders with an Inflation Index Ratio to calculate any principal adjustments resulting from a change in the consumer price index.