1.1.6 Inflation Linked Bond Process

This topic provides systematic instructions to inflation linked bond process.

To create an Inflation-Linked Bond (ILB) instrument, navigate to the Instrument Management module within the system and select the option to create a new instrument. Choose ILB as the instrument type. In the Instrument Creation screen, provide the required details by selecting the appropriate index reference code for inflation (e.g., Consumer Price Index – CPI), specifying the lag period in months (e.g., 3 months) between the index reporting and its application to the bond, and selecting an interpolation method if applicable (e.g., linear interpolation between two index data points). Next, enter the nominal amount (face value) of the ILB instrument. Once all details are completed, click Save or Create to finalize and store the ILB instrument.

1. Navigate to the relevant ILB instrument to review how inflation adjustments are applied.
2. The system adjusts the principal automatically based on the movement of the configured inflation index.
3. The adjusted principal is calculated using the index ratio derived from the base index and the current index for the valuation date.
   The calculation is performed as follows:

   • Index Ratio = Current Index / Base Index
   • Adjusted Principal = Face Value × Index Ratio
4. The system determines the current index using the index lag defined at the instrument level and applies the index corresponding to the lag-adjusted date.
5. The latest available index (based on the defined lag) is used to calculate the adjusted principal.
6. If a principal floor is defined, the system ensures that the adjusted principal does not fall below the original face value.

   Note:

   Index values are maintained in the system as part of market data. If index data is unavailable for a given date, the system uses the last available index or applies interpolation logic based on configuration.

   • Coupon Processing for ILB:

     Coupon payments for ILB securities are processed based on the adjusted principal applicable on the coupon date.

     The coupon amount is computed as follows: Coupon Amount = Adjusted Principal × Coupon Rate × Period Fraction

   • Redemption Processing for ILB:

     At maturity, the redemption amount is determined using the adjusted principal derived from the final applicable index.

     The redemption amount is calculated as follows: Redemption Amount = Face Value × Final Index Ratio

     Where, Final Index Ratio = Index at maturity (considering lag) / Base Index

7. At redemption, if a principal floor applies, the redemption amount will not be less than the face value.
8. For partial or intermediate redemptions (if applicable), the system calculates amounts using the adjusted principal corresponding to the relevant schedule date.

   Core calculations for the linked bonds:

   Adjusted Principal = Nominal × (Reference Index / Base Index)

   Coupon = Adjusted Principal × Coupon Rate × Day Count Fraction

   Redemption = Nominal × (Final Index / Base Index)

   Redemption = Max (Nominal, Adjusted Principal)

   Follow the below process to create inflation linked bonds.