1
$\begingroup$

t2=forward settlement date

P=Spot clean price

AI0=Spot accrued interest

r=repo rate

t1=coupon payment date

AIt2= accrued interest of the forward settlement date

t0= now

Proceeds Method:

F(t2)=(P+AI0)(1+r*t2)−c2(1+r(t2−t1))−AIt2.

I want to understand how inflation affects this formula if we do this for a inflation linked bond.

$\endgroup$
4
  • $\begingroup$ do we need to consider the coupons which are not falling in between settlement date and forward settlement date? $\endgroup$ Commented Jun 26, 2018 at 19:58
  • $\begingroup$ Not explicitly. Those coupons are discounted into the linker's price. $\endgroup$
    – Helin
    Commented Jun 27, 2018 at 9:04
  • $\begingroup$ what does discounted into linker's price mean? $\endgroup$ Commented Jun 27, 2018 at 21:05
  • $\begingroup$ I was being overly precise. What I meant is that the linker's price is the discounted present value of all future coupons and principal payments, so from that perspective, coupons not between spot date and forward date are implicitly accounted for. But you should just ignore this precision – you don't need to worry about coupons paid out after the forward date. $\endgroup$
    – Helin
    Commented Jun 28, 2018 at 0:33

1 Answer 1

2
$\begingroup$

It's pretty much the same as a nominal bond, except cash flows need to be inflated. For example, here's the forward pricing formula for a Canadian-style linker, assuming one interim coupon payments:

$$ \bigl(F(t_f) + AI_{t_f}\bigr) \frac{I(t_f)}{I_\text{base}} = (P + AI_{t_s})\cdot \frac{I(t_s)}{I_\text{base}}\cdot (1 + r \cdot t_f) - c\cdot \frac{I(t_c)}{I_\text{base}}\cdot\bigl(1 + r\cdot (t_f - t_c)\bigr), $$ where $t_f$ represents the forward settlement date, $t_s$ is the spot settlement date, $t_c$ is the coupon date, and $I(t)$ is the index ratio for time $t$.

Note that if all the index ratio terms are removed, you've got the nominal bond forward pricing formula.

If the indexed ratios corresponding to the coupon date and forward settlement dates are not known, you'll need a projection curve to impute them.

$\endgroup$
12
  • $\begingroup$ what will be the formula for a imperial-style linker? $\endgroup$ Commented Jun 27, 2018 at 21:14
  • $\begingroup$ is this not the formula which Bloomberg uses to calculate the forward price of a inflation linked bond? $\endgroup$ Commented Jun 27, 2018 at 21:22
  • $\begingroup$ It's the same for any bond/linker – you just need to inflate all the cash flows into nominal terms accordingly. And yes, it's the formula BBG uses when you choose Proceeds method. $\endgroup$
    – Helin
    Commented Jun 28, 2018 at 0:32
  • $\begingroup$ inflate all the cashflows into nominal terms accordingly means to use the inflation curve accordingly or is there any other difference? $\endgroup$ Commented Jun 28, 2018 at 4:45
  • $\begingroup$ The most common practice on the sell side is actually to use economists' inflation forecasts. You can also use inflation swap curve for a market-based gauge. $\endgroup$
    – Helin
    Commented Jun 28, 2018 at 5:30

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge you have read our privacy policy.

Not the answer you're looking for? Browse other questions tagged or ask your own question.