The US Treasury issues Inflation-Protected Securities, also known as TIPS. TIPS are issued with maturities...
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The US Treasury issues Inflation-Protected Securities, also known as TIPS. TIPS are issued with maturities of 5, 10, and 30 years and are considered a low-risk investment because the U.S. government backs them. The principal of TIPS is tied to the Consumer Price Index, which is measured by the non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI-U), which is published by the Bureau of Labor Statistics of the U.S. Department of Labor. With inflation, the principal increases. With deflation, it decreases. When the security matures, the U.S. Treasury pays the original or adjusted principal, whichever is greater. 1) Suppose we purchase a 10-year TIPS with $10,000 face value and 2% coupon rate at a price of $11,300. For simplicity, we assume the bond pays interest only once a year at the end of the year, although it is twice a year in reality (January and July). What is the yield of this TIPS? 2) Suppose for a similar 10-year Treasury bond of $10,000 face value and 2% coupon rate, the auction price is $10,400. What is the yield of this Treasury bond? 3) What is the expected inflation over the next 10 years that is implied by the above yields?
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