Consider an investor who, on January 1, 2014, purchases a TIPS bond with an orig
ID: 2710046 • Letter: C
Question
Consider an investor who, on January 1, 2014, purchases a TIPS bond with an original principal of $110,000, an 12 percent annual (or 6 percent semiannual) coupon rate, and 15 years to maturity. Suppose that the semiannual inflation rate for the second six-month period is 1.3 percent. Calculate the inflation-adjusted principal at the end of the second six months (on December 31, 2014) and the coupon payment to the investor for the second six-month period. What is the inflation-adjusted principal on this coupon payment date? (Round your answers to 2 decimal places. (e.g., 32.16))
Explanation / Answer
Answer: Adjusted Coupon $6515.30
and adjusted Principal $108,588.35
Inflation means price level has increased. This means What we bought with $100 can not buy now with $100. if inflation rate is 1.3% then we can buy same goods with $100 x (1+0.013) = $101.03 So how much we can buy = 100/101.03 = 0.98980501 portion of the goods previously purchased goods Same way we can reduce principal 110,000/(1+0.013)=$108,588.35 Similarly Coupons can be adjusted as 6600/(1+0.013) = 6515.30