Inflation Protected Securities – Definition

Cite this article as:"Inflation Protected Securities – Definition," in The Business Professor, updated March 20, 2019, last accessed August 4, 2020, https://thebusinessprofessor.com/lesson/inflation-protected-securities-definition/.

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Inflation Protected Securities Definition

In trading parlance, Inflation Protection is the adjustment of value in the price of securities, with respect to inflation. Prices of securities, their payouts, and dividends, are adjusted periodically in keeping with the rate of inflation. Inflation is the rise of prices for goods and services.

For e.g., A health insurance contract that carries a price adjustment clause in case of an increase in the prices of medical services.

A Little More on What are Inflation Protected Investments

Inflation Protection mitigates the risk of inflation on an investment portfolio by diversifying it. Common instances of Inflation Protection are:

Treasury Inflation Protected Securities (TIPS)

Treasury Inflation Protected Securities – TIPS – are securities adjusted for inflation. The price value of the security is adjusted in the Consumer Price Index with respect to fluctuating inflation rates, while the interest on it remains fixed on the treasury. This makes Inflation Protected Securities available at very low risk factor as well as low interest rates in the bonds market.

TIPS perform well during rise in inflation. Conversely, ROI on TIPS is low if there’s no rise in inflation during the lifetime of these securities. They also require tax adjustments in accordance with the adjustments made due to inflation.

Inflation Protected Commodities

Some Commodities like gold are used to hedge against inflation as the price of commodities is directly proportional to inflation. Returns on Inflation Protected Commodities are better than TIPS, as TIPS tend to have a lower interest rate. The downside to this is that Commodities carry the risk of reduced production and regional output. Other factors may also influence the sensitivity of commodities overtime to inflation. An alternative way of hedging against inflation in commodities’ prices is to invest in stock options of companies that produce these commodities.

References for Inflation Protection

Academic Research on Inflation Protection

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