Question

1. You buy a TIPS at issue at par for $1,000. The bond has a 6% coupon. Inflation turns out to be 2%, 3% and 4% over the next 3 years. Figure out the sum of principal and coupon payment in Year 3.

Please show work for both, coupon payment and Sum of principal

Answer 1

TIPS par values are adjusted to inflation:

In year one if the inflation rate is 2%, the par value will become=1000*(1+.02)=$1020

But the coupon payment will be the same=6%

therefore in year 1 the coupon payment will be =1020*.06=$61.20

similarly for year 2,the coupon payment will be =1030*.06=$61.80

similarly for year 3,the coupon payment will be =1040*.06=$62.40

As question asked for pricipal , I consider it has 3 year maturity period.

SO adjusted par value to inflation=$1040

Coupon payment=$62.40

Total payment=$1102.40

I hope above is clear, but still there is doubt please let me know.Hope to seeing positive feedback