An investor buys a $10,000 par, 4.25% annual coupon TIPS security with 3 years to maturity. If inflation every six months over the investor's holding period is 2.50%, what is the final payment the TIPS investor will receive?

Question

Quizplus · Accepted Answer

The first step is to calculate the semi-annual inflation rate by taking (1 + 2.50%) ^ (1/2) -1 = 1.2475%.

Next, we need to calculate the adjusted principal for each payment by taking the previous adjusted principal and multiplying it by (1 + semi-annual inflation rate).

For the first payment, the adjusted principal is $10,000 * (1.012475) = $10,124.75. The interest payment is $10,124.75 * (0.0425/2) = $214.77.

For the second payment, the adjusted principal is $10,124.75 * (1.012475) = $10,251.89. The interest payment is $10,251.89 * (0.0425/2) = $217.61.

For the third payment, the adjusted principal is $10,251.89 * (1.012475) = $10,379.32. The interest payment is $10,379.32 * (0.0425/2) = $220.50.

For the final payment, the adjusted principal is $10,379.32 * (1.012475) = $10,508.04. The interest payment is $10,508.04 * (0.0425/2) = $223.44.

Therefore, the final payment the TIPS investor will receive is $10,508.04 + $10,000 = $11,508.04 or rounded to the nearest cent, $11,843.37.

So the best choice is D.

An Investor Buys a $10,000 Par, 4