Inflation-linked bonds (also known as linkers) are bonds that provide protection against inflation. In such type of bonds their principals are linked to inflation, which serve to minimize inflation risk. This means their principal is increased by the change in inflation over a period. The first known inflation-indexed bond was issued by the Massachusetts Bay Company in 1780. The British government began issuing inflation-linked Gilts in 1981.

Most common inflation-linked bonds are:

The principal amount of the bond increases with inflation, thus the interest rate is applied to the increased amount. This causes the increase in interest payment over time. At maturity, the principal is repaid at the inflated amount. This ensures that an investor has complete inflation protection. In most countries, the Consumer Price Index (CPI) or its equivalent is used as an inflation proxy.

Inflation-linked bonds can be properly understood by comparing them to vanilla bonds.

Let us, for the purpose of our comparison take the British Government 8% bond maturing in 2020. Compare this with the British "Inflation-linked Gilt" (ILG) the 4.5% maturing in 2021. The principal increases with inflation, which is based on the British CPI. For example, when British inflation, the CPI, was 1.4% in 1995, the principal amount was increased by 1.4%. Since its issue in November 1990, the ILG has seen its principal amount increase by 4% to £104. The 4.5% coupon now generates a payment of £4.68 versus its original payment of £4.5. At maturity, the principal amount will increase with inflation and might get return more than a normal bond with the increase in its principal amount.

An inflation-linked bond protects the investor from unexpected changes in the consumer price index. Investors do not necessarily expect inflation to be high, since they do not know what the future will bring they are willing to sacrifice some current yield for inflation protection on the principal.