Question

Suppose that the coupon rate for a TIPS is 4%. Suppose further that an investor purchases $50,000 of par value initial principal) of this issue today.
(1) What is the dollar coupon interest that will be paid in cash at the end of the first six months if the current rate of inflation is 3.25%?
(2) What is the dollar coupon interest that will be paid in cash at the end of the first year if the rate of inflation increases to 3.75% six month later?

Answer 1

Answer:

1. $1,016.25

2. $1,035.30

Explanation:

Dollar coupon interest = Par value * (1+inflation/2)*coupon rate/2

1. Dollar coupon interest = 50000* (1+3.25%/2)*4%/2

Dollar coupon interest = 50,000*(1+3.25%/2)*4%/2

Dollar coupon interest = 50,000*1.01625*0.02

Dollar coupon interest = $1,016.25

2. Dollar coupon interest = 50,000*(1+3.25%/2)*(1+3.75%/2)*4%/2

Dollar coupon interest = 50,000*1.01625*1.01875*0.02

Dollar coupon interest = 1035.3046875

Dollar coupon interest = $1,035.30