The following questions are about TIPS.
a. What is meant by the “real rate”?
b. What is meant by the “inflation-adjusted principal”?
c. Suppose that the coupon rate for a TIPS is 3%. Suppose further that an investor purchases $10,000 of par value (initial principal) of this issue today and that the semiannual inflation rate is 1%.
1. What is the dollar coupon interest that will be paid in cash at the end of the first six months?
2. What is the inflation-adjusted principal at the end of six months?
d. Suppose that an investor buys a five-year TIPS and there is deflation for the entire period. What is the principal that will be paid by the Department of the Treasury at the maturity date?
e. What is the purpose of the daily index ratio?
f. How is interest income on TIPS treated at the federal income tax level?