Hi everyone, I was wondering if theoretically inflation was 2%/ year, and you put your money into a 1 year bond (1.75%), wouldn't you theoretically be losing money? (1.75 - 2 = -.25%)
From my understanding, TIPS are protected against inflation, but I believe that all bonds are not protected against inflation.
Forgive me, I am just confused with this topic.
Most bonds are fixed rate instruments that are not protected against inflation. This is why duration risk is such a core concept in bond investing.
You would absolutely be losing money as well as opportunity cost and a few others.
TIPS adjust daily, so they're not the classic fixed income instrument. Depending on the type of bond you buy, you will either receive semi-annual interest payments based on the rate of the bond you bought (a 5% bond would yield 2.5% per semi-annual payment), while a zero-coupon bond is bought at a steep discount, you receive no interest payments, but the bond matures at par ($1000).
There are also General Obligation and Revenue bonds, but these are munis. Different instruments than a government or corporate bond.
FYI, you're probably aware, high-yield (junk) bonds provide higher returns due to the higher risk, as the bonds are backed by the full faith and credit of the corporation. Government bonds have lower yield, but are backed by full faith and credit of the US gvmt. So, as close as you can get to a non-default fixed income instrument.
Considering you're buying a "fixed income" instrument, you are getting the yield stated on the face of the certificate. Period. If inflation is 3% and rising and your bond portfolio is yielding 2.5%, you're losing money.
In a scenario you've described, you will be losing money in real terms.
A fixed coupon (nominal) bond will not offer inflation compensation.
A bond will only provide protection against inflation if it has a floating rate indexed to inflation.
Fixed rate instruments are susceptible to inflation.
Longer duration bonds are supposed to price in the expected inflation and expected forward rates. So it would have to be inflation above the current expectations of the present and future.
Sort of. I really think they trade at a spread to ngdp and not inflation. Which is slightly different.
And they trade at a spread to ngdp that reflects the spread buyers and sellers are willing to transact at. There at strong reasons why that spread can be negative and buyers are willing to lose money in real terms.
Floaters do exist, there are Tender Offer Bonds and ive also seen some companies issue LIBOR spread debentures.
High yield bonds typically have lower sensitivity
You could also look at international bonds which sometimes have low/no correlation to the US economy.
Same with premium coupon bonds. These are issued with a higher rate but sold at a premium to par.
Yes and no. QE is definitely playing a part in that equation, but with US tapering and hiking, I don’t think that’s as much the case anymore. You can make that argument for corporates since the secondaries have had low volume. But for us 10 yr, I think that it should price in inflation rather than ngdp. (It could be pricing in pce deflator rather than CPI tho)
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