Question

Suppose that you buy a TIPS (inflation-indexed) bond with a 1-year maturity and a coupon of 6% paid annually. Assume you buy the bond at its face value of $1,000, and the inflation rate is 8%.

a. What will be your cash flow at the end of the year?

b. What will be your real return?

c. What will be your nominal return?

Answer 1

cash flow at the end of year
face value		1000
inflation rate		8%
inflation adjusted value of bond	1000*1.08	1080
coupon payment = 1080*6%		64.8
cash flow at the end of year		1144.8
Nominal return in value	1144.8-1000	144.8
real return in value	1144.8-1080	64.8
Nominal return in % =(cash flow at the end of year/cash outflow at the beginning)-1	(1144.8/1000)-1	0.1448 = 14.48%
real rate of return in %	14.48-8	6.48