An Index Linked Bond is one in which bond cash flows are calculated with reference to future inflation rates. As at 2008, government issued index linked bonds exceeded $1.5 trillion. This modelling guide explains how to model index linked bonds.

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INDEX
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LINKED BONDS
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Financial Modelling
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5. An Index Linked Bond is one in which bond cash flows are
calculated with reference to future inflation rates. As at 2008,
government issued index linked bonds exceeded $1.5 trillion.
This modelling guide explains how to model index linked bonds.
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ACCOMPANYING EXCEL EXAMPLE
HANDBOOK
INDEX
LINKED BONDS
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CALCULATING INTEREST
The first part of the interest calculation looks at interest without inflation.
This is done by applying a periodic interest rate to the un-indexed beginning
balance of the bond.
Formula in cell J14 = $F10 / $F11 * J12 * J13
Since the annual interest rate was quoted on a 30 / 360 basis, it has been
converted to a periodic rate by dividing it by quarters in a year.
1
1

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UN-INDEXED BOND BALANCE
The un-indexed repayments are calculated by multiplying the total bond amount by
the repayment profile.
Formula in cell J19 = $F17 * J18
2
3
The un-indexed bond balance is calculated using the bond balance at the start of
forecast period; the calculated un-indexed repayments reduce the balance and are
modelled in a cork screw.
Formula in cell J27 = IF(J23 = 1, J22, J25 - J26)
2
3

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INDEXED INTEREST
The un-indexed interest calculated at step 2 is now indexed, using an indexation
factor specific to the bond (and documented in the bond documentation). This gives
the indexed bond interest.
Formula in cell J41 = J39 * J40
4
4

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REPAYMENTS AND BALANCE
The indexed principal repayment and indexed bond balance are both calculated by
multiplying the un-indexed amounts by a specific indexation factor.
Formula in cell J47 = J45 * J46
Formula in cell J53 = J51 * J52
The index linked bond repayment is exported to the cash flow statement.
5
5

10. In an inflationary environment, the balance of an index linked bond increases
even if there are neither cash movements nor further borrowings.
Consequently, if there are bond repayments, the bond balance will be reduced by
an amount that is less than the bond repayments.
In a deflationary environment, the opposite will happen.
Changes in the bond balance arising from inflation are charged through the
income statement.
INDEXATION

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INDEXATION (CONT.)
The change in the index linked bond balance is the difference between
current and previous period balances.
Formula in cell R58 = (R56 - Q56) * R57
6
7
The indexation charge is calculated by summing the change in the index linked bond
balance and the indexed repayments made.
The indexation charge is the sum of repayments calculated in step 5 and the change
in the index linked bond balance calculated in step 6.
Formula in cell Q62 = SUM(Q60:Q61)
6
7

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INDEX LINKED BOND BALANCE
The indexation charge calculated in step 7 is added to the bond balance, while the
indexed repayments are deducted from the bond balance.
Formula in cell J72 = IF(J67 = 1, J66, J69 + J70 - J71)
The balance for an index linked bond can be calculated using a standard cork screw.
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