Reconsider a 3.25 percent TIPS that was issued with CPI reference of 186.7. 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 201.1. Now, at the end of the year, the CPI is 202.4 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) 1.6 percent
B) 2.4 percent
C) 5.8 percent
D) 9.1 percent

Question

Quizplus · Accepted Answer

The total return includes both the interest payments and the inflation adjustment to the principal. The inflation-adjusted principal at the end of the year is calculated using the CPI at the end of the year relative to the reference CPI. The interest payments are based on the adjusted principal. The total return is the sum of the interest payments and the change in principal value, expressed as a percentage of the initial principal.