Question

Use the following information to answer the next four questions.

An investor purchases a newly issued TIPS bond with an original principal of $107,000, an 8 percent coupon rate, and 15 years to maturity on January 1, 2014. Suppose that inflation over the first six months after purchasing the bond is .3 percent.

1. What is the inflation-adjusted principal at the end of the first six month period?

2. Calculate the value of the first coupon payment. Round your final answer to two decimals. Do not use the dollar sign when entering your answer.

3. Suppose that the inflation rate for the second six-month period is 1.0 percent. Calculate the inflation-adjusted principal at the end of the second six months (on December 31, 2014).

4. Calculate the value of the second coupon payment. Round your final answer to two decimals. Do not use the dollar sign when entering your answer.

Answer 1

1. The Inflation Adjusted Principal at the end of first six month period is obtained by multiplying the original par value by one plus the semi annual inflation rate .

Original par value = $ 107000

Semi annual Inflation = 0.3%

Coupon rate = 8% annually or 4% semiannually

So Inflation Adjusted Principal at the end of first six month period = 107000* (1+ 0.003) = $107321

2. Value of first Coupon Payment = Inflation Adjusted Principal at the coupon date * coupon rate = 107321*0.04 = $4292.84

3. Second six month Inflation rate = 1%

After the end of first six month the principal is $ 107321

So Inflation Adjusted Principal at the end of second six month period = 107321* (1+ 0.01) = $108394.21

4. Value of second Coupon Payment = Inflation Adjusted Principal at the coupon date * coupon rate = 108394.21*0.04 = $4335.77