Inflation-linked Federal Securities are debt securities issued by the Federal Republic of Germany. They are available with original maturities of five to more than ten years. Because their redemption and annual interest payments are linked to a consumer price index, they offer protection against the loss of purchasing power of the invested money.

Inflation-linked Federal notes and bonds are debt securities with a fixed maturity of 5 or 10, up to 30 years. Unlike classical Federal bonds and notes, their nominal interest rate is not fixed. Like the redemption amount at maturity, it is based on the development of an official consumer price index.

This serves to compensate for price increases in goods and services that occur during the bond's holding period. In this process, both the interest payments and the nominal value acquired are adjusted by the inflation rate - the purchasing power of the entire investment sum is maintained. The "price" for this is the lower fixed (since real) coupon of the indexed Federal securities - compared to classic Federal bonds or notes without this protection against inflation.

This fixed real coupon of an inflation-linked Federal bond or Federal note represents the real interest rate at the time of issuance for the corresponding maturity. It roughly corresponds to the long-term average economic growth.

The annual coupon payments are adjusted for inflation according to the index ratio:

Interest payment = nominal value x coupon x indexation coefficient on the interest date

This adjustment ensures an annual real interest rate equal to the fixed coupon in the event of inflation.

Simplified, exemplary sample calculation: Nominal and real development of interest payments of an inflation-linked Federal bond with a fixed coupon of 1.5 % over the first three years at an annual inflation of 2 %.

In the event of redemption at maturity, the nominal value is increased by the inflation development determined during the maturity in accordance with the indexation coefficient, the nominal redemption amount increases.

At maturity:

Redemption amount (nominal) = Nominal value x  Indexation coefficient on the date of maturity

During maturity:

Market value= Nominal value x Stock exchange price x Indexation coefficient

Diese Anpassung gewährleistet den realen Werterhalt des angelegten Geldes

Simplified, exemplary sample calculation: Nominal and real development of the redemption amount of an inflation-linked Federal bond over the first three years with an annual inflation of 2 %

The basis for the indexation of inflation-linked Federal securities is the unrevised harmonised index of consumer prices (HICP) excluding tobacco. It is determined by Eurostat, the statistical office of the European Community, and published monthly as an inflation index number.

The relative change in this inflation index number over a calendar year reflects the annual inflation rate in the euro zone. With a three-month lag, this monthly inflation index is taken into account for inflation-linked Federal securities.
Due to this lag, the index numbers for the current month can already be published at the beginning of the month. However, since inflation-linked Federal securities can be bought and sold daily on the stock exchange, the index must also be calculated on a daily basis.

For holders of inflation-linked Federal securities, the indexation coefficient is the easiest way to track the inflation trend. For the sake of clarity, it is set to the value "1" by default on the day of the first interest run and subsequently adjusted daily by the inflation trend.

During the maturity, the coefficient can be used to read on any given day how inflation has developed since the security's first interest maturity date.

Both the inflation index and the indexation coefficient and interest payments reflect the inflation trend by increasing by the same amount of 2.0 % in all full years (e.g. index 2008 / index 2007 = 1.020 = ratio 2008 / ratio 2007 = interest amount 2008 / interest amount 2007).
Since the first interest year with 396 days is longer than a calendar year, the values are relatively larger here compared to the subsequent years. Inflation here is 1.020 to the power of (396/365) days and the interest amount (at a coupon of 1.5%) for the first year of maturity is 10,000 x 1.02172 x 1.5% x 396 / 365 = 166.27 euros. The ratio of the inflation index to its initial value at the start of the interest term (15.03.2006) can be read off conveniently every year from the index ratio. For example, on the maturity date, the identical development of the index ratio figure and the redemption amount (€10,000 acquired nominal value x ≈1.22105 = €12,210.46 redemption amount) can be seen directly.

Inflation-linked Federal securities offer a fixed real interest coupon, as their nominal interest payments offset the inflation trend. The nominal repayment amount is protected against inflation at maturity. The inflation compensation is based on the development of the harmonised consumer price index for the eurozone.

After their issuance in an auction process, inflation-linked Federal bonds and notes are traded on the stock exchange. They are subject to a price risk just like nominal-linked Federal bonds and notes, which can, however, be neglected if they are held to maturity.

With inflation-linked Federal securities, investors with a medium- to long-term investment horizon can preserve the purchasing power of their invested money.
Compared to an investment in classic bonds with fixed nominal interest rates, the purchase of inflation-linked Federal securities is more advantageous if inflation is higher in the future than the market already expects today.

During the maturity, a price gain attributable to increased inflation expectations, among other things, can increase the value of an inflation-linked Federal bond. Likewise, associated changes in the interest rate level on the bond market can also influence the price of the bond.

Although inflation-linked Federal bonds are always issued at a price close to 100 % and redeemed at 100 % at maturity, but changes in market interest rates and inflation expectations usually cause their market price to fluctuate daily during the maturity.  So when bought after issue, they are usually likely to be purchased at prices below 100 % or, thanks to inflation compensation, more likely to be above 100 %.

The price movements during the maturity of inflation-linked Federal securities take place in particular according to the following mechanisms:

1. If the real market interest rate rises, the bond price falls - if the real market interest rate falls, the bond price rises.
2. The bond price rises and falls with inflation expectations.

The extent of the price reaction depends on the bond's features:

The longer the remaining maturity and the lower the coupon of the inflation-linked Federal bond, the more strongly its stock market price usually reacts to changes in interest rates on the bond market.

Issuer risk

The Federal Republic of Germany is liable for the repayment of inflation-linked Federal securities with its assets and tax revenues. Its ability to meet the payment obligations arising from inflation-linked Federal securities determines the issuer risk. This risk is considered to be extremely low. Like all Federal securities, inflation-linked Federal securities are gilt-edged.

Price risk

The prices of inflation-linked Federal securities move in the opposite direction to real yields on the bond market.
Especially in the event of an increase in real yields on the bond market - e.g. as a result of unexpectedly declining inflation rates and thus inflation rates that are overestimated by the market - investors can suffer capital losses when selling inflation-linked Federal securitites before maturity.
While in the event of persistent deflation (declining indexation coefficient, possibly below 1.0) the redemption amount at maturity is always at least equal to the nominal value, the interest payment may be lower than the product of coupon and nominal value.
The price risk is higher (high) for inflation-linked Federal bonds with a maturity of ten years or more than for inflation-linked Federal notes (medium), but can be eliminated by holding the securities until maturity.

Liquidity risk

The risk of not being able to sell Federal Securitites at any time before maturity is very low, as inflation-linked Federal securities are among the most heavily traded sovereign bonds in the euro area and the Finance Agency and the Bundesbank maintain the market.

Possible issuance dates are published by the Deutsche Bundesbank six days before the issuance.

Banks and savings banks

Inflation-linked Federal bonds and notes can be bought and sold at credit institutions on each trading day. Fees may be charged for purchase, custody or sale. In principle, there are no minimum or maximum limits for the purchase or sale.

Finance Agency

Only inflation-linked Federal securities issued by 21 August 2012 can be managed at the Finance Agency. While safekeeping in a debt register account is free of charge, an effect commission is incurred for the Deutsche Bundesbank if sold before maturity.

In the stock exchange listing, the inflation compensation (via indexation coefficient) is not taken into account, which is why purchasers usually have to spend a higher purchase amount than the stock exchange price implies! This is because in the case of inflation-linked securities, both the nominal value (and stock market price) and the accrued interest are multiplied by the indexation coefficient.
For example, a total of € 110.49 was needed to buy 100 euros' face value of the inflation-linked Federal notes shown above at a market price of 104.11 % on 3 August 2009. € 109.78 market value [from market price x indexation coefficient x nominal value] + € 0.71 accrued interest.