Question

A $1,000 9% TIPS bond pays interest annually. You buy the bond at par when the CPI=100. After one and two years, the CPI is 120 and 130, respectively .  What is your nominal rate of return in the second year

Answer 1

Nominal rate = 9%

A TIPS bond adjusts its par value according to inflation. If inflation is 20% during the course of a year, a $1,000 par value TIPS would turn into a $1,200 par value even if the secondary market price of the TIPS declined over the same time.and the coupon payment would instead be $108 (1,200 x 9%). so the nominal rate of interest will remains the same at any level of inflation

here the price will be 1,000 x 120/100 = 1,200

and the return = 1,200 x 9% = 108

Nominal rate = 108 / 1200 = 9%