Question

The following table shows $1,000 face value Treasury bonds and TIPS of different maturity lengths. Assume that all of the bonds have the same coupon rate:  

Bond #	Type	Maturity Length	Yield (%)
1	Treasury Note	10-Year	4.05
2	Treasury Bond	20-Year	5.35
3	TIPS	10-Year	2.05
4	TIPS	20-Year	2.85

Based on the information in the table, we can assume that traders in the TIPS market expect that the annual average inflation rate will _____ from over the next ten years to over the next twenty years.

Select one:

a. remain constant

b. increase

c. decrease

d. either increase, decrease, or remain constant

The following table shows $1,000 face value Treasury bonds and TIPS of different maturity lengths. Assume that all of the bonds have the same coupon rate:  

Bond #	Type	Maturity Length	Yield (%)
1	Treasury Note	10-Year	4.05
2	Treasury Bond	20-Year	5.35
3	TIPS	10-Year	2.05
4	TIPS	20-Year	2.85

Based on the information in the table, we can assume that traders in the TIPS market expect that the annual average inflation rate will _____ from over the next ten years to over the next twenty years.

Select one:

a. remain constant

b. increase

c. decrease

d. either increase, decrease, or remain constant

Answer 1

Ans. = (Option B) Increase

We can assume that traders in the TIPS market expect that the annual average inflation rate will Increase from over the next ten years to over the next twenty years.

because TIPS is a Inflation protected Security. So, if the Inflation Rises then the Holders of TIPS Securities would be given the same Real Return as before.

TIPS = Treasury Inflation Protected Securities.

So, Traders in TIPS market are Expecting Inflation Rate to Increase as only then they will buy these Securities. If they don't expect Inflation to Rise then they wouldn't buy these TIPS.

Because the Return is Lower in TIPS as compared to Treasury Bond. But If Inflation Rises then only they will have benifit as compared to Treasury Bond.

For period of 10 Years - If Inflation rises more than 2% (4.05 - 2.05) then only TIPS traders would have benifit.

For period of 20 Years - If Inflation Rises more than 2.5% (5.35 - 2.85) then only TIPS traders would have benifit.

_______________________________________

Please UPVOTE if you find this Answer Helpful and Post your Doubts (if any) in the comment section.

Thanks
_______________________________________