If inflation rises, the yields for TIPS will: A) rise and their price will fall. B) rise and their price will rise. C) fall and their price will rise. Which of the following statements regarding TIPS is most accurate? TIPS have: A) inflation risk but no credit risk. B) credit risk but no inflation risk. C) no credit risk and no inflation risk.
C C
Follow-up question: Other than changes in the rate of inflation, what are two other factors that impact the yields on inflation-indexed bonds?
- A 2. C Supply of TIPS, Demand for TIPS.
McLeod81 Wrote: ------------------------------------------------------- > Follow-up question: > > > Other than changes in the rate of inflation, what > are two other factors that impact the yields on > inflation-indexed bonds? 1. Changes in the anticipated rate of inflation. 2. Changes in risk-aversion of investors.
GetSetGo Wrote: ------------------------------------------------------- > 1. A > 2. C > > Supply of TIPS, Demand for TIPS. You might want to re-think that one GSG 
For question one, i understand that price will rise. For yield, how is that calculated? Is it just the coupon payments or is the upward principal adjustment somehow factored in?
I am changing to 1. B 2. C thanks Dwight for pointing out.
If inflation rises, the yields for TIPS will: A) rise and their price will fall. B) rise and their price will rise. C) fall and their price will rise. Your answer: C was correct! If inflation starts rising, the yields for U.S. Treasury Inflation Protected Securities (TIPS) will actually fall and their prices will rise because the demand for them increases as investors seek out their inflation protection. Which of the following statements regarding TIPS is most accurate? TIPS have: A) inflation risk but no credit risk. B) credit risk but no inflation risk. C) no credit risk and no inflation risk. Your answer: C was correct! U.S. Treasury Inflation Protected Securities (TIPS) are both credit risk and inflation risk free.
nerdattax Wrote: ------------------------------------------------------- > For question one, i understand that price will > rise. For yield, how is that calculated? Is it > just the coupon payments or is the upward > principal adjustment somehow factored in? This tripped me up too, the first time I looked at it. The yield is like the yield calculation on a zero coupon bond. TIPS don’t have a coupon payment. The relationship is counter-intuitive. When inflation increases, yields actually DECREASE because investors bid up the price of the securities because of inflation.
Gotcha. That makes sense that prices and yields move in opposite directions though I am nearly certain that TIPs still have a coupon payment. One thing I’ve learned about TIPs is that they are very squirrely. The more I learn about them, the more questions I have. For instance, how would you evaluate the duration on a TIP. As you say, prices increase with inflation (which will typically be accompanied by an increase in interest rates).
During which phase of the business cycle would TIPS be least useful to a portfolio manager? A) Initial recovery. B) Early expansion. C) Slowdown.
I was wrong, TIPS do have a coupon payment. It is a fixed percentage of the principal (which fluctuates with inflation). “Treasury Inflation-Protected Securities, or TIPS, provide protection against inflation. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater.” “TIPS pay interest twice a year, at a fixed rate. The rate is applied to the adjusted principal; so, like the principal, interest payments rise with inflation and fall with deflation.” “You can buy TIPS from us in TreasuryDirect and Legacy Treasury Direct through non-competitive bidding. Starting in January 2007, the 20-year TIPS is no longer sold in Legacy Treasury Direct, but it continues to be available in TreasuryDirect.”
I’ll go with C. In today’s environment people are more worried about deflation than inflation so there is little benefit of the inflation protection. Plus, if you buy them in the secondary market, your built up principal adjustment could be eroded.
A edit: Because TIPS are still bonds (treasuries specifically), and bonds will perform well in a slowdown.
I think C because inflationary pressures would be lowest during an economic slowdown, and the TIPS inflation protection is least valuable when prices are falling.
Inflationary pressures are low during an economic slowdown, but they are lower at the very bottom of the business cycle (right before initial recovery). Inflation is still falling during the initial recovery.
good point mcleod - for example, if right now we’re (hopefully) in the very early innings of economic recovery, inflationary pressures are about as low as we’ll see them, and here the inflation hedge is less desirable than at other points in the biz cycle.
I will go with C also. I thought yield on TIPS is its coupon. Obviously my assumption was wrong.
The real yield is its coupon, but the nominal yield is the coupon/mkt price, which will move with changes in real rates and supply/demand for TIPS… does that sound right?