Question

Consider a newly issued TIPS bond with a 3-year maturity, par value of $1,000, and coupon rate of 4.00%. Assume annual coupon payments.
Time Inflation in
Year Just Ended Par Value Coupon Payment + Principal Repayment = Total Payment
0 $ 1,000.00
1 2.0% $ 1,020.00 $ 40.80 0 $ 40.80
2 1.0 % $ 1,030.20 $ 41.21 0 $ 41.21
3 3.0 % $ 1,061.11 $ 42.44 $ 1,061.11 $ 1,103.55
What is the nominal rate of return on the TIPS bond in the first year?
a. 3.00%
b. 4.08%
c. 6.08%
d. 6.00%

Answer 1

Answer: c. 6.08%

Explanation:

The return for the first year is given as;

= Coupon payment / Par Value

= 40.80/ 1,000

= 4.08%

TIPS are inflation protected securities so this return is the real return. Nominal return is;

= Real return + inflation

= 4.08% + 2.0%

= 6.08%