DEFINITION of Corporate Inflation-Linked Securities
Corporate inflation-linked securities (CIPS), also referred to as inflation-linked bonds, are fixed income securities that have a coupon rate that is indexed to inflation. As the bond yields adjust monthly, they provide an income that responds rapidly to changes in inflation.
BREAKING DOWN Corporate Inflation-Linked Securities
Corporate inflation-linked securities can provide investors with some inflation protection, like Treasury inflation-protected securities (TIPS) -whose bond principal varies with inflation. They also provide extra diversification, as they have a low correlation with other asset classes, and can reduce a bond portfolio's interest rate sensitivity or duration, because they are usually offered with maturities of five to ten years. However, there is a trade-off. When inflation is low, CIPS produce below-average returns compared to traditional corporate bonds.
The coupon rate — which can have a ceiling, and may only be partially floating — is typically aligned with an established measure of inflation such as the consumer price index, and updated monthly. For example, we have a corporate inflation-linked bond with a coupon rate of 5.000%, and a par value of $1,000. When purchased, the bondholder would receive $50 per year in payments. If, because of inflation, bond holders should receive, $75 per year, then the coupon rate needs to increase to 7.500% (7.500% x $1,000 = $75).
Corporate Inflation-Linked Securities Are Not Mainstream
The majority of CIPS are issued by financial institutions. Because most of these issues are small, it is hard for retail investors to find CIPS offerings — unless they work with a specialist bond broker. And while CIPS do provide investors with much higher nominal yields, they expose investors to the same credit risk, interest rate risk and default risk as regular corporate bonds.