Question

A ​$1,000 Treasury​ inflation-protected security is currently selling for ​$973 and carries a coupon interest rate of 4.09 percent

a. If you buy this​ bond, how much will you receive for your first interest​ payment, assuming no interest adjustment to principal during this time​ period?

b. If​ there's a 0.83 percent increase in​ inflation, what will be the new par value of the​ bond?

c. What is your new semiannual interest​ payment?

d. What would the par value be at​ maturity, assuming a 2.50 percent annual inflation rate and​ ten-year maturity​ period?

Answer 1

TIPS Treasury inflation-protected security adjusts themselves to the inflation by adjusting its par value.

Tips pay interest every 6 months.

A. Interest payments = 1000*(4.09%)*(6/12)
= 20.45

B. The adjusted par value of the Bond = par value at starting x(1+ inflation rate).

At the end of year 1 = 1000(1+0.0083)
=1008.3

C. Interest payments =1008.3*(4.09%)*(6/12)
= 20.62

D. The adjusted par value of the Bond at the end of 10 years = par value at starting x(1+ inflation rate)^10

= 1000x(1+ 0.025)^10
=1280.08