Question

Consider an “annual” TIPS with standard coupon rate of 105 with the par value of $10000. Assume there was inflation of 8% during the year. How much is the annual coupon payment for the year?

Answer 1

Given par value = $ 10,000

Coupon interest = $ 105

Coupon interest rate =( Interest amount/ Face value) *100

=( $ 105/$ 10,000)*100

= 1.05%

Hence the standard Coupon rate = 1.05%

Inflation rate = 8%

In TIPS, Principal gets adjusted according to inflation

Adjusted principle = Original amount ( 1+inflation rate )

= $10,000( 1+0.08)

= $ 10000*1.08

= $ 10800

Adjusted principle is $ 10800

Now that principe got adjusted interest will come on Adjusted principle

Interest for the Year = Adjusted principle * Standard Coupon rate

= $ 10800*1.05%

= $ 113.40

Annual Coupon payment for the year is $ 113.40

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