Inflation bond gets big rate increase

Discussion in 'Wall St. News' started by SethArb, Nov 3, 2005.


    excerpt from journal yesterday ...

    -Tuesday, the Treasury Department sharply increased the yield on its I Bond savings bond to 6.73 percent from 4.8 percent previously. The rate adjusts twice a year, based on the consumer-price index, or CPI.

    -Many experts say that only a small portion of one's portfolio -- typically 5 percent to 10 percent -- should be parked in inflation-linked products. -

    -Investment professionals caution investors to look beyond the I Bond's current 6.73 percent yield and focus instead on how that yield is calculated. The rate paid on the I Bond has two parts: a fixed-rate that lasts for the 30-year life of the bond and an inflation adjustment that is tied to the CPI for the preceding six months. The inflation adjustment is made twice a year, on May 1 and Nov. 1.-

    -The new inflation adjustment, announced Tuesday, is 5.73 percent, reflecting the steep increase in the CPI over the last six months. That's the highest inflation adjustment on record since the bonds were first launched by the U.S. government in September 1998. At the same time, the Treasury cut the fixed rate on new issues to 1 percent from 1.2 percent. That means investors who buy I Bonds can expect a 1 percent return after inflation.-

    -"People are going to look at the headline number and talk about how good the I Bond is," said Greg McBride, a senior financial analyst with "But the I Bond didn't get better. It got worse." He says the fixed-rate is more important to investors over the long term because it remains constant for the life of the bond; the inflation-adjustment, by contrast, changes every six months.-

    -If inflation moderates, investors could wind up earning higher returns on other low-risk investments, such as high-yield money-market funds, high-yield bank money market accounts and CDs. Rates for one-year CDs can be as high as 4.65 percent, according to, while some five-year CDs have yields of as much as 5 percent.-
  2. sle


    I don't think he is right - the bond is puttable (non-put period is 12M) to the US govt, the first 5 years it's a 3m earning exec. cost, after 5 years put option is free. It is pretty simple to stick this structure (CPI-adjusted cpn, puttable bond) into any derivative pricing system and you can see that in fact, I Bonds are MORE expensive then their face value (assuming low inflation downside volatility, which is a pretty good assumption).

    In fact, if you buy 30k worth of I Bonds, you are long massive amounts of long-dated rates vega that you can sell in the form of eurdollar options (or swaptions, if you have access) to enchance your yield.