Skip to main content
No. of Recommendations: 0
I’ve discovered some constants that are useful in calculating the inflation-adjusted yield of a bond and --not immodestly-- named them “Charlie’s Inflation Constants”.

This is the problem. For a single bond, such as a 5-year bond with a 10% coupon bought at par, it’s a straight-forward matter to calculate its inflation-adjusted yield (assuming a 5% inflation-rate) using the brute-force method of calculating each coupon payment by hand and then summing them. But for hundreds of bonds, a simpler method is needed. Intuitively, it would seem that the average, discounted coupon-payment could be obtained by using a factor equal to half of its holding-period. But, in fact, using “2” as a divisor in the formula misstates the results. But using a slightly different factor produces exactly the right result over any time-frame and for any coupon. For other inflation-rates, different constants are needed. Where my math skills break down is in discovering, by formula, the formula needed to produce the constant needed for any rate of inflation, though I can produce a fitted equation which closely describes the schedule of constants I’ve derived, and that’s all the hint you math whizzes need to reverse-engineer what I’ve done (aka, solve for X).

f(x) = 0.079657143x^2 - 1.1913714x + 5.91853, when the range of inflation values is 4.0% to 6.0%
You do remember your high-school, freshman algebra, right? LOL

Summary: Brute-force methods can be used to produce a useful schedule of discounting constants for selected inflation-rates, because it’s not as if guesses about the forward-rate of inflation need to be very precise. The number merely needs to be as close to a worst-case scenario as one is willing to risk suffering a shortfall of income. The advantage of selecting a constant for your own situation is that it now becomes possible to incorporate your tax-rate into the same formula and to predict, for any bond, hundreds of bonds at a time, what their real-rates of return will be (all other things being equal), so that just the very few worth considering further can be selected for study.

Building your own tools, and be able to run your own numbers, is what successful investing is all about and why I can make the exceptional money I do from bonds, just as Jack does the same for stocks, because he builds the tools he needs for them. (But he's nicer than I am, and he shares. LOL)

Charlie
Print the post  

Announcements

What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.