Question

2) INFLATION-INDEXED TREASURY BOND Assume that the U.S. economy experienced deflation during the year and that the consumer price index decreased by 1 percent in the first six months of the year and by 2 percent during the second six months of the year. If an investor had purchased inflation-indexed Treasury bonds with a par value of $10,000 and a coupon rate of 5 percent, how much would she have received in interest during the year

Answer 1

She received $490.05 during the year.

Step-by-step explanation:

The principal of the bond will decrease in cash of decrease in the consumer price index.

The principal can be calculated as follow

Principal Value = ( Face value x Percentage reduction in consumer price index )

For the First Six Months

Principal Value = ( $10,000 x ( 100% - 1% ) = $9,900

For the Last Six Months

Principal Value = ( $9,900 x ( 100% - 2% ) = $9,702

Now calculate the coupon payments using the following formula

Coupon payments = Principal value x Coupon rate x Time fraction

For the First Six Months

Coupon payments = $9,900 x 5% x 6/12 = $247.50

For the Last Six Months

Coupon payments = $9,702 x 5% x 6/12 = $242.55

Total Interest received = Interest received in First Six Months + Interest received in Last Six Months = $247.50 + $242.55 = $490.05