Question

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

Answer 1

Answer:

Total annual coupon income for year 3  = $33.00

Explanation:

given data

buy a TIPS = $1000

annual coupon = 3%

Inflation turns out = 2%, 3%, and 4%

solution

TIPS ( Treasury Inflation Protected Securities)  is US treasury bonds which is index to inflation.

so here total annual coupon income for year 3 express as

total annual coupon income for year 3  = (  par value × coupon rate ) × ( 1 + inflation rate year 1  ) ×  ( 1 + inflation rate year 2  ) × ( 1 + inflation rate year 3 )   .........................1

put here value and we will get

Total annual coupon income for year 3 = ($1,000 × 3%) ×  ( 1+2%)  × ( 1+3%)  ×  ( 1+4%)

Total annual coupon income for year 3 =  $30 x 1.0200 x 1.0370  x 1.0400

Total annual coupon income for year 3  = $33.00