Reconsider a 2.75 percent TIPS that was issued with CPI reference of 191.7. The bond is purchased at the beginning of the year (after the interest payment), when the CPI was 197.5. For the interest in the middle of the year, the CPI was 205.2. Now, at the end of the year, the CPI is 204.4 and the interest payment has been made. What is the total return of the TIPS in percentage terms for the year? (Assume semiannual interest payments and $1,000 par value.)
A) 2.75 percent
B) 5.60 percent
C) 6.35 percent
D) 6.80 percent

Question

Quizplus · Accepted Answer

The total return includes both the interest payments and the inflation adjustment to the principal. The semiannual interest is calculated based on the adjusted principal. The principal adjustment is (204.4/191.7) * $1,000. The interest payments are based on the adjusted principal at the beginning and middle of the year. The total return is the sum of the interest payments and the change in principal value, expressed as a percentage of the initial principal.