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Definition: Inflation-Linked Certificates Of Deposit
Certificate of deposit whose interest rate instead of being fixed, varies with that of the inflation rate prevailing in the issuers country are called Inflation-Linked Certificates Of Deposit. Here the interest rate on the certificate is decided taking into account the inflation rate so the annual or semi-annual interest payments will be decided on the bases of the inflation rate prevailing in the country. So at the time of maturity one would get the principal amount plus the inflation adjusted interest rate.
Suppose an investor buys Inflation-Linked Certificates Of Deposit with face value of 100 Rs with coupon rate of 4% annually and the certificate matures after a year and at the end of that year inflation rate was 3%. Then at the end of 1st year the investor will get its principal of 100 Rs along with that he will get 3 Rs on the basis of inflation rate so its principal now becomes 103 Rs then his interest payment will be 4.12 Rs (103*4%).So his total return becomes 107,12 Rs at the end of one year.
Issued by the U.S. Treasury, this type of certificates are traded in the primary and secondary market.
It is preferred by those investors who want lower risk in their investment and want to invest for a long period of time. This certificate provides them return as per the present value of the money and at real rate instead of nominal rate, so this protects and diversifies the investors’ money.
The disadvantage of this certificate is that its fixed coupon payment rates are less compared to other certificate of deposits as it reduces the investor’s risk of inflationary changes.
This certificates are also taxable so whatever amount the investor receives at the maturity will be considered as a taxable income.