Question

1. Suppose the inflation-adjusted principal balance of a TIPS security is $10,150 and the original face value is $10,000. If the coupon rate is 3% and the inflation rate is 2% (annualized), how much interest will the investor receive at the end of the first six months?

2. In regard to the same TIPS (with adjusted face value of $10,150), if inflation remains at the same level, what would be the inflation-adjusted principal at the end of the first year?

Hint: Compound the inflation adjusted principal from the first period.

The coupon rate for a TIPS is 3%. Suppose further that an investor purchases $10,000 of par value (initial principal) of this issue today and that the annualized inflation rate is 2%.

Answer 1

1. Suppose the inflation-adjusted principal balance of a TIPS security is $10,150 and the original face value is $10,000. If the coupon rate is 3% and the inflation rate is 2% (annualized), how much interest will the investor receive at the end of the first six months?

Interest = Adjusted Principal balance * Coupon rate / 2

Interest = 10150 * 3% / 2

Interest = $152.25

2. In regard to the same TIPS (with adjusted face value of $10,150), if inflation remains at the same level, what would be the inflation-adjusted principal at the end of the first year?

inflation-adjusted principal at the end of the first year = inflation-adjusted principal balance at first period * (1 + Inflation/2)

inflation-adjusted principal at the end of the first year = 10150 * 1.01

inflation-adjusted principal at the end of the first year = $10251.50