Question

Suppose a portfolio manager purchases 1mio USD of par value TIPS. The coupon rate determined at the auction is 3,2%.a.Assume that the end of six months the CPI is 3,6% (annual rate)b. Compute the inflation adjustment to principal at the end of 6 months.c.Compute the inflation-adjusted principal at the end of 6 monthsd. The coupon payment made to the investor at the end of six months.

Answer 1

Given

Amount purchased $1,000,000

Coupon rate at auction = 3.2%

CPI at end of six months = 3.6%

Now,

Inflation adjustment to the principal at the end of first six months

$1,000,000 * 0.036/2 = $18,000

Inflation adjusted principal = $1,000,000 * (1+ 0.036/2) = $1,000,000 * 1.018 = $1,018,000

Coupon payment at the end of first six months = one half of the coupon rate at auction * inflation adjusted principal at end of first six months= (0.032/2) *1,018,000 = 0.016 *1,018,000 = $16,288