Estimating a TIPS Nominal Yield with an Asset Swap

Summary

The document describes a way to estimate a nominal yield for an inflation-linked bond such as a US TIPS. The method constructs an asset swap with one leg reproducing the bond’s inflation-adjusted cash flows and another leg paying in nominal currency. The nominal leg’s principal amounts are set to match the bond’s inflation-adjusted repayments, and its coupons are solved so that both legs have equal present value.

The yield calculated from the nominal leg is then used as the bond’s nominal yield. The answer points to observable bond and inflation swap quotes as the market inputs for the calculation. It does not provide a worked example, pricing conventions, or details on discounting and curve construction, so implementation requires additional market-specific assumptions. The question’s assumption that future CPI stays at its current value is not developed further in the answer; the proposed method instead frames the calculation through bond and inflation swap cash flows.

Key ideas

• An asset swap can translate inflation-linked bond cash flows into a nominal-currency leg.
• The nominal leg’s principal repayments should follow the bond’s inflation-adjusted principal repayments.
• Solve the nominal coupons so the inflation-linked and nominal legs have equal present values.
• Use the yield of the nominal leg as the estimated nominal yield of the linker.

Tags

# Calculating nominal yield of linker


# Calculating nominal yield of linker












Assuming all future CPI values are equal to the current CPI value, how would I calculate the nominal yield of a linker - specifically TIPS?

## Answer by Dimitri Vulis (score 0)

https://quant.stackexchange.com/a/83761

For inflation-linked bonds similar to US TIPS, Mexican Udibonos, Brazil NTN-B, and the like:

Construct an asset swap, where the "bond" leg mimics the inflation-linked cash flows of the bond, and the other "nominal" leg is in nominal currency - not inflation-adjusted.

The "nominal" leg's notionals should match the bond's inflation-adjusted principal repayments.

Solve for the nominal leg coupons so that both legs have the same present value, using the observable quotes of your bond and of inflation swaps.

Calculate the "yield" of the "nominal" leg and call it the "nominal" yield of your bond.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.