ILB Processing Example 2

An entity purchases 100,000,000.00 of a U.S. TIP; CUSIP 9182727R8. This security pays a semiannual 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, and is calculated as follows:

((Nominal Shares * ILB Index Ratio * Coupon Rate) / Payment Frequency/Actual Number of Days in the Period) * Number of Days Earned in the Period
or
100,000,000 * 1.15941 * .035 /2/184 (Number of Days in the Period from 7/15/06 to 1/15/07) * 171 (Number of Days in the Period from 1/15/07 to 7/15/06) = 1,885,616.54

The 100,000,000.00 nominal shares is then fully closed out with a trade date of 01/03/07, a settlement date of 01/03/07, and at a price of 100.00. The close ILB index ratio is 1.15936 and the traded interest is 1,896,643.53. In this scenario, the entity needs to recognize <5000.00> of deflationary ILB income. This is calculated as follows:

(100,000,000.00 * (1.15936 - 1.15941) Plus 1 Day of Accrued Interest, 10,945.20
(1,896,561.74 Interest Sold - 1,885,616.54 Interest Purchased by Settlement Date Minus 1)

In this scenario there are two options to recognize the income.

First, you can earn on 1/2/07 using the 1/2/07 ILB index of 1.15941, recognize 11,026.99 of interest income, and recognize zero inflationary income, as the accrual and open ILB index ratios are the same. You then have to recognize <5000.00> of deflationary ILB income and <81.79> of interest income on settlement date in order to correctly reflect the income numbers on the tax lot, which use the settlement date's tips index ratio and interest sold.
The second option is the method used in Eagle Accounting. Eagle Accounting accrues on 01/02/07 using the 01/03/07 ILB Index ratio. The result is 10,945.20 of interest income (100,000,000.00 * 1.15936 * .035 / 2 / 184 * 172 - traded interest from the buy), and <5000.00> of inflation income (100,000,000.00 * (1.15936 - 1.15941). There is no income accrual for this tax lot on 01/03/07. By using the next day's ILB index ratio, the lot is fully accrued at the end of each day. You do not need a catch up entry on the settlement date of a disposition, because the lot is fully accrued on coupon date minus one.

The smoother stream of income is shown more clearly when the settlement date is greater than 1 day from the open trade. In this scenario the open is the same as above, but the close has a trade date of 01/02/07 and a settlement date of 1/11/2007.