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The Price and Interest Payments on TIPS

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Consider an investor who, on January 1, 2011, purchases a TIPS bond with an original principal of $100,000, an 8% annual (or 4% semiannual) coupon rate, and 10 years to maturity.

a. If the semiannual inflation rate during the first six months is 0.3%, calculate the principal amount used to determine the first coupon payment and the first coupon payment (paid on June 30, 2011).

b. From your answer to part b, calculate the inflation-adjusted principal at the beginning of the second six months.

c. Suppose that the semiannual inflation rate for the second six-month period is 1%. Calculate the inflation-adjusted principal at the end of the second six months (on December 31, 2011), and the coupon payment to the investor for the second six-month period is the inflation-adjusted principal on this coupon payment date.

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Solution Summary

This solution demonstrates the computation of the semi-annually adjusted price and coupon (interest) payment on Treasury Inflation-Protected Securities.

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Treasury Inflation-Protected Securities are Treasury bonds issued at face value with a fixed interest rate; however, that face value varies according to the rate of inflation (or deflation). The semi-annual interest payment remains at the stated rate, ...

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