. What is the relationship between the bonds and inflation(or deflation)

Hi acsurendan and welcome to the FM forums.

I don't tend to play with bonds as they're a bit too low risk/low return for me, but as I understand it there are two main types of bonds

1. Fixed interest
2. Inflation indexed

Fixed interest bonds pay a set interest rate over a set period. You're basically buying into debt for a company/government so in some ways you're basically funding a fixed-rate loan.

Inflation indexed bonds have a built in mechanism where the underlying principal varies with the inflation rate. It's important to know that this doesn't mean the bond interest rate changes directly with inflation. Think of it more as a multiplier, such as interest rate times x, where x is the principal and this is modified by the inflation rate.

I think that's how the majority of index-linked bonds work. I think there are some that are tied directly to the rate of inflation and that the Australian government is one of them so go careful to make sure you know which type of bond you're actually looking to buy into.

Hope that helps.

Guess that sums up everything, inflation indexed bonds are directly related to inflation/deflation and you need to take this more into consideration.