Now lets consider a different type of government bond, a ten-year inflation indexed bond. Payments on this bond are adjusted for inflation based on the CPI. If inflation rises by five percent, interest payments on this bond will rise by five percent.
Interest rates on this type of bond (excluding the added inflation adjustmen) are very low because again, they include only two of the components of an iterest rate. Which two are most important?
-Positive rate of time prederence
-Expected inflation rate
-Transaction costs of screening and monitoring borrowers
-Risk that the borrowers will default
-General uncertainty about the future
Take a shot, what do you think. Use your last post and my response to guide your thinking
Based on the information provided in the previous response, the two most important components that are included in the interest rates on a ten-year inflation indexed bond are:
1. Expected inflation rate: The interest rate on an inflation indexed bond is adjusted for changes in inflation. If the expected inflation rate increases, the interest rate on the bond will also increase to account for this expected rise in inflation. Therefore, the expected inflation rate is an important component in determining the interest rate on this type of bond.
2. Positive rate of time preference: The concept of time preference refers to the idea that individuals typically prefer to receive money earlier rather than later. A positive rate of time preference implies that individuals require compensation for delaying consumption or investment. This compensation is reflected in the interest rate on the bond, as bondholders are essentially lending money for a specific period, and they expect to be rewarded for postponing the use of that money.
Therefore, the two most important components that are included in the interest rates on a ten-year inflation indexed bond are the expected inflation rate and the positive rate of time preference.