Question

Compute the annual interest payments and principal amount for a Treasury Inflation-Protected Security with a par value of $1,200 and a 3-percent interest rate if inflation is 4 percent in year 1, 5 percent in year 2, and 6 percent in year 3.

Answer 1

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

Year 1:

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

At the end of year 1 = 1200(1+0.04)

=1248

Interest amount = 1248*3% = 37.44

Year2:

At the end of year 2 = 1248(1+0.05)

=1310.4

Interest Amount= 1310.4*3% = 39.31

Year 3:

The adjusted par value of the Bond =

At the end of year 1 = 1310*(1+0.06)

=1388.6

Interest Amount = 1388.6*3% = 41.66