An entity purchases 100,000,000.00 of a US TIP; CUSIP 9182727R8. This security pays a semi-annual inflation adjusted coupon payment at 3.5%. It has an actual/actual day count basis and pays coupons on January 15th and July 15th. The open transaction has a trade date of 01/02/07 and settlement date of 01/02/07. The opening unit price is 100.00 and the ILB index ratio is 1.15941. The inflation adjusted shares are 115,941,000.00. The traded interest on the open transaction is 1,885,616.54 (see ILB Processing Example 1 for calculation).
The full position of 100,000,000.00 is closed with a trade date of 01/02/2007, a settlement price of 100, a settlement date ILB index ratio of 1.15891, and sold interest of 1,984,003.530 (100,000,000.00 *1.15891 *.035 /2/184)*180 days. The inflation adjusted shares are 115,891,000 (100,000,000.00 *1.15891)
By using the methodology of accruing daily income with the next day's ILB index ratio, the security in this scenario would accrue the inflation income shown in the following table.
Traded Date ILB Index Ratio | ILB Index Ratio used in Earnings | ILB Income | Accrual Delta | PTD Accrual | Total Receivable | |
|---|---|---|---|---|---|---|
Jan 2 2007 | 1.15941 | 1.15936 | -5,000.00 | 10,945.20 | 10,945.20 | 1,896,561.74 |
Jan 3 2007 | 1.15936 | 1.15930 | -6,000.00 | 10,927.80 | 21,873.00 | 1,907,489.54 |
Jan 4 2007 | 1.15930 | 1.15925 | -5,000.00 | 10,943.20 | 32,816.20 | 1,918,432.74 |
Jan 5 2007 | 1.15925 | 1.15919 | -6,000.00 | 10,925.62 | 43,741.82 | 1,929,358.36 |
Jan 6 2007 | 1.15919 | 1.15914 | -5,000.00 | 10,941.21 | 54,683.03 | 1,940,299.57 |
Jan 7 2007 | 1.15914 | 1.15908 | -6,000.00 | 10,923.42 | 65,606.45 | 1,951,222.99 |
Jan 8 2007 | 1.15908 | 1.15902 | -6,000.00 | 10,922.28 | 76,528.73 | 1,962,145.27 |
Jan 9 2007 | 1.15902 | 1.15897 | -5,000.00 | 10,938.17 | 87,466.90 | 1,973,083.44 |
Jan 10 2007 | 1.15897 | 1.15891 | -6,000.00 | 10,920.09 | 98,386.99 | 1,984,003.53 |
The alternative method of this is to use the Trade ILB Index Ratio, which would cause zero inflation linked income that is recognized on day 1. This would result in an ILB income accrual delta and true up on settlement date of the close transaction. This methodology fails for two reasons. First, it reflects zero inflation linked income on settlement date of the open transaction. Secondly, it requires income accruals on settlement date of a close transaction. This does not to adhere to industry standards of accruing income through settlement date minus one.
The security in the scenario that follows would reflect the inflation income shown in the following table.
Traded Date ILB Index Ratio | ILB Index Ratio used in Earnings | ILB Income | Accrual Delt | PTD Accrual | Total Receivable | |
|---|---|---|---|---|---|---|
Jan. 2 2007 | 1.15941 | 1.15941 | 0.00 | 11,026.99 | 11,026.99 | 1,896,643.53 |
Jan. 3 2007 | 1.15936 | 1.15936 | -5,000.00 | 10,944.73 | 21,971.72 | 1,907,588.26 |
Jan. 4 2007 | 1.15930 | 1.15930 | -6,000.00 | 10,927.23 | 32,898.95 | 1,918,515.49 |
Jan. 5 2007 | 1.15925 | 1.15925 | -5,000.00 | 10,942.73 | 43,841.68 | 1,929,458.22 |
Jan. 6 2007 | 1.15919 | 1.15919 | -6,000.00 | 10,925.04 | 54,766.72 | 1,940,383.26 |
Jan. 7 2007 | 1.15914 | 1.15914 | -5,000.00 | 10,940.73 | 65,707.45 | 1,951,323.99 |
Jan. 8 2007 | 1.15908 | 1.15908 | -6,000.00 | 10,922.86 | 76,630.31 | 1,962,246.85 |
Jan. 9 2007 | 1.15902 | 1.15902 | -6,000.00 | 10,921.71 | 87,552.02 | 1,973,168.56 |
Jan. 10 2007 | 1.15897 | 1.15897 | -5,000.00 | 10,937.69 | 98,489.71 | 1,984,106.25 |
Jan. 11 2007 | 1.15891 | -6,000.00 | -102.72 | 98,386.99 | 1,984,003.53 |
The alternative method is to true-up accruals on settlement date minus one using the settlement date ILB Index Ratio. This method fails in two ways. First, it would again cause zero inflationary income to be recognized on settlement date. Secondly, it creates a "blip" of inflation income on settlement date minus one.
Traded Date ILB Index Ratio | Next Day ILB Index Ratio | ILB Income | Accrual Delta | PTD Accrual | Total Receivable | |
|---|---|---|---|---|---|---|
Jan. 2 2007 | 1.15941 | 1.15941 | 0.00 | 11,026.99 | 11,026.99 | 1,896,643.53 |
Jan. 3 2007 | 1.15936 | 1.15936 | -5,000.00 | 10,944.73 | 21,971.72 | 1,907,588.26 |
Jan. 4 2007 | 1.15930 | 1.15930 | -6,000.00 | 10,927.23 | 32,898.95 | 1,918,515.49 |
Jan. 5 2007 | 1.15925 | 1.15925 | -5,000.00 | 10,942.73 | 43,841.68 | 1,929,458.22 |
Jan. 6 2007 | 1.15919 | 1.15919 | -6,000.00 | 10,925.04 | 54,766.72 | 1,940,383.26 |
Jan. 7 2007 | 1.15914 | 1.15914 | -5,000.00 | 10,940.73 | 65,707.45 | 1,951,323.99 |
Jan. 8 2007 | 1.15908 | 1.15908 | -6,000.00 | 10,922.86 | 76,630.31 | 1,962,246.85 |
Jan. 9 2007 | 1.15902 | 1.15902 | -6,000.00 | 10,921.71 | 87,552.02 | 1,973,168.56 |
Jan. 10 2007 | 1.15897 | 1.15891 | -11,000.00 | 10,834.97 | 98,489.71 | 1,984,003.53 |
Jan. 11 2007 |
With regards to amortization yields and amortization, Eagle Accounting calculates a prospective amortization yield based on the current principal cost and an applicable amortization rule. Barring any changes to prepayment assumptions, reference data that affects yield (changes in inflation do not affect yield), or which amortization rule is used, the amortization yield that is calculated on settlement date of the trade remains constant over the life of the ILB bond. Eagle Accounting applies amortization based on the applicable amortization rule established in the entity/accounting basis setup. Note that Eagle Accounting calculates an adjusted issue price, as of settlement date of the transaction, for entity/ accounting bases that recognize OID.
Similar to earnings, Eagle Accounting views the unrealized gain/loss process as an end of day process and also uses the next day's ILB index ratio. The unrealized gain/loss process is executed after earnings are completed, as earnings affect the cost of investment. In the case of ILB, earnings affect the shares used in calculating unrealized gain/loss.
The earnings process affects the cost of the position, and the inflation adjusted shares, by using the following day's ILB index ratio. Therefore, this same ratio is used in the unrealized gain/loss process. Using the current day's trading ILB index ratio would cause incorrect gain/loss postings, as the cost of investments would already reflect the change in inflation.