Question

A customer buys a $1,000 par Treasury Inflation Protection security with a 4% coupon and a 10 year maturity. If the inflation rate during the first year of the security's life is 5%, the:________

I) coupon rate is adjusted to 9%
II) coupon rate remains at 4%
III) principal amount is adjusted to $1,050
IV) principal amount remains at $1,000
A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 1

C. II and III

Step-by-step explanation:

Treasury Inflation-Protected Securities are a type of US treasury bond that safeguards investors from the adverse effects of inflation. The bonds are indexed to the inflation rate. The bond's principal amount increases with rising inflation and decreases with deflation as captured by the CPI. The bond pays a fixed interest rate twice per year. At maturity, the Treasury Inflation-Protected Securities pay the adjusted amount in the books.

In this case, the TIPS principal amount will be adjusted by a 5% inflation rate. The new principal amount will be;

1000 x 1+ 5/100 = 1000 x 1.05

=$1050

The interest rate or coupon rate remains the same