You buy a TIPS at issue at par for $1,000.The bond has a 3% coupon.Inflation turns out to be 2%,3% and 4% over the next three years.The total annual coupon income you will receive in year three is _________.

Question

Quizplus · Accepted Answer

The coupon payments for the next three years will be:
Year 1: $30.00 x 1.02 = $30.60
Year 2: $30.00 x 1.03 = $30.90
Year 3: $30.00 x 1.04 = $31.20
The total coupon income in year three will be $31.20. However, because TIPS are adjusted for inflation, $31.20 is not the final answer. We need to adjust for inflation by dividing by the inflation rate in year three, which is 4%. $31.20/1.04 = $30.00. Therefore, the answer is (C) $32.78.

You Buy a TIPS at Issue at Par for $1,000