Question

Consider an investor who, on January 1, 2019, purchases a TIPS bond with an original principal of $117,000, an 12 percent annual (or 6 percent semiannual) coupon rate, and 12 years to maturity. a. If the semiannual inflation rate during the first six months is 0.2 percent, calculate the principal amount used to determine the first coupon payment and the first coupon payment (paid on June 30, 2019)

b. From your answer to part a, calculate the inflation-adjusted principal at the beginning of the second six months.

c. Suppose that the semiannual inflation rate for the second six-month period is 1.3 percent. Calculate the inflation-adjusted principal at the end of the second six months (on December 31, 2019) and the coupon payment to the investor for the second six-month period.

(For all requirements, round your answers to 2 decimal places. (e.g., 32.16))

Answer 1

TIPS Bond are treasury inflation protected securities bonds which are created to protect the investor against the rising inflation.
The coupon payment under these bonds are calculated on the bond's par value which is adjusted for inflation rate.
Formula to calculate principal payment of TIPS bond
Principal Payment = Par Value of Bond*Semiannual inflation rate
a) Calculation of principal payment of TIPS Bond
The semi annual inflation rate during the first six months is 0.2 percent
Therefore the principal amount would be adjusted upwards
Principal amount = 117,000*(1.002)
Principal amount		$117,234.00
The principal amount to determine the first coupon payment is $117,234
Calculation of coupon payment which is calculated by multiplying coupon rate with the principal amount
Coupon payment = $117,234*0.06
Coupon payment		$7,034.04
The coupon payment on 30th June 2019 will be $7,034.04
b) Since the inflation rate would remain same the principal amount at the beginning of the second six months would be $117,234
c) In the second six month period the semi annual inflation rate is 1.3 percent
Therefore the principal payment would be upward by 1.3 percent
Principal amount = 117,234*(1.013)
		$118,758.04
The principal amount at the end of the second six months would be $118,758.04
Calculation of coupon payment
Coupon payment would be on the principal amount at end of the second six month period
Coupon payment = $118,758.04*0.06
		$7,125.48
The coupon payment on 31st December 2019 will be $7,125.48