Question

6P CH 6. Consider an investor who, on January 1, 2016, purchases a TIPS bond with an original
principal of $100,000, an 8 percent annual (or 4 percent semiannual) coupon rate, and 10
years to maturity. ( LG 6-2)

a. If the semiannual inflation rate during the first six months is 0.3 percent, calculate the
principal amount used to determine the first coupon payment and the first coupon payment
(paid on June 30, 2016).

b. From your answer to part a, calculate the inflation-adjusted principal at the beginning of the
second six months.

c. Suppose that the semiannual inflation rate for the second six-month period is 1 percent.
Calculate the inflation-adjusted principal at the end of the second six months (on December
31, 2016) and the coupon payment to the investor for the second six-month period. What is the
inflation-adjusted principal on this coupon payment date?

Answer 1

a-	principal amount used to calculate interest at the end of first semiannual period	principal*(1+inflation rate)	100000*(1.003)	100300
a-	amount of coupon payment at the end of first semiannual period	principal value at the end of 1st semiannual period * annual coupon rate/2	100300*8%/2	4012
B-	inflation adjusted principal at the beginning of 2nd six month			100300
C-	inflation-adjusted principal at the end of the second six months	principal*(1+inflation rate)	100300*(1.01)	101303
C-	amount of coupon payment at the end of second semiannual period	principal value at the end of 1st semiannual period * annual coupon rate/2	101303*8%/2	4052.12
	inflation-adjusted principal on this coupon payment date			101303