Question

Individual E purchased a newly issued Treasury Inflation-Protected Security (TIPS) for $100,000 to add to E's retirement fund. The coupon rate is 3%. But, coupon payments are made semi-annually. The face value changes at the rate of inflation using the Consumer Price index. Given that the CPI was 247 at the time of purchase, was 253 at 6 months when the first interest payment was made and was 260 at 12 months when the second interest payment was made. What are the amounts of the first and second interest payments?

Answer 1

Interest payment = Face value x Semi-annual Coupon rate where

Semi-annual coupon rate = 3% / 2 = 1.5%

(A) After 6 months,

Face value = $100,000 x (CPI after 6 months / Initial CPI) = $100,000 x (253 / 247) = $102,429

First Interest payment (after 6 months) = Face value x Semi-annual coupon rate = $102,429 x 1.5% = $1,536.44

(B) After 12 months,

Face value = $100,000 x (CPI after 12 months / Initial CPI) = $100,000 x (260 / 247) = $105,263

Second Interest payment after 12 months = $105,263 x 1.5% = $1,578.95