Question

An investor purchases a TIPS bond with a 3% coupon. During the first year, if the inflation rate is 8%, the principal value of the security at the end of that year will be closest to:_________

Answer 1

assuming that the cost of the bond was originally $1,000, its principal will be adjusted to $1,000 x (1 + 8%) = $1,080 at the end of the year.

Step-by-step explanation:

TIPS stand for Treasury Inflation-Protected Securities, which means that the principal value of the security will be adjusted to inflation. The coupon rate is not adjusted, but since the principal is, if inflation rises, you will receive a higher coupon rate and the maturity value of the security will also increase.