Efficient Investment Portfolios in a Real-Value Environment: Implications for Portfolio Managers and Bond Yields

By Herbst, Anthony F.; Perg, Wayne F. | International Journal of Business, Winter 2001 | Go to article overview

Efficient Investment Portfolios in a Real-Value Environment: Implications for Portfolio Managers and Bond Yields


Herbst, Anthony F., Perg, Wayne F., International Journal of Business


ABSTRACT

In early 1997 the U.S. Treasury began issuing inflation-indexed securities. This paper compares efficient portfolios containing an inflation-indexed security to portfolios without such a security. Inflation risk premiums that are required for traditional, nominal, non-indexed debt assets to replace an inflation-indexed security in efficient portfolios are estimated. Results are calculated and compared for the periods 1926-1995,1950-1995 and 1965-1995.

JEL: G11, G12, D81

Keywords: Real return; Inflation-adjusted; Portfolio management; TIPS (for Treasury Inflation-Protected Securities); Indexation

I. INTRODUCTION

Until early 1997, when the U.S. Treasury issued inflation-indexed bonds, U.S. investment managers had no asset that provided an assured inflation-indexed return (1). Availability of inflation-indexed securities-constant-dollar-value assets--now offers new opportunities for optimizing portfolio risk-return tradeoff. This also poses new challenges, because some things considered to be true turn out to be false, or at least questionable, in the presence of inflation-indexed securities, when everything is benchmarked in real terms.

In real, constant dollar terms over a multi-period investment horizon, a nominal dollar U.S. Treasury bill, the traditional risk-free asset, turns out to be anything but risk free. This is due to the uncertain future rate of inflation and the turnover of investment at future interest rates that cannot be known in advance.

For the purposes of this study we assume that a security exists that offers a guaranteed fixed return after the effects of inflation. At present, those indexed securities that exist closely approximate, but do not exactly satisfy this ideal, because of lags in making the inflation adjustment (2) and the tax treatment accorded the adjustment. (3) Fluctuations in the market's real rate of return will affect the realized real rate of return, but a buy and hold strategy will minimize variations in the real rate of return. To approximate the actual (and worst case) results that may be expected with the new U.S. Treasury TIPS (Treasury Inflation Protected Securities), we examine the effects of lagging the inflation indexed return by 1, 2, and 3 months.

II. A BRIEF HISTORY OF INFLATION-INDEXED SECURITIES

The U.S. Treasury is a latecomer to offering inflation-adjusted securities. In modern times Finland in 1945 was the first nation to offer inflation adjustment in government financial instruments. Since then, many other nations have issued such debt. Table 1 shows the dates of implementation of inflation indexation in countries whose national governments offer such securities.

In January, 1997 the United States issued its first inflation indexed bonds in two centuries. (4) The initial securities offered were 10-year inflation-indexed notes. This was followed by a 5-year inflation-indexed note and a 30-year bond. These securities are issued with a single price in a Dutch auction, as are the current non-indexed 2- and 5-year notes. Bidding is on the basis of real yield, expressed to three decimal places. The index used to measure inflation is the CPI-U, the non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers, which is published monthly by the Bureau of Labor Statistics of the U.S. Department of Labor. (5) The market yield on these securities, over the inflation rate, has remained around 3-5/8 percent.

Issue of inflation-indexed securities by the federal government will likely pave the way for acceptance of privately issued inflation adjusted securities. (6) Also, the current tax treatment of the phantom income from inflation adjustment may serve to focus public attention on how current U.S. tax law penalizes preservation of purchasing power, and thus may eventually help lead to revision of the tax code. In the U.K. there is no tax on the "inflation-induced increase in the nominal principal. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

Efficient Investment Portfolios in a Real-Value Environment: Implications for Portfolio Managers and Bond Yields
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.