Question

You have a 2-year maturity TIPS of 6% coupon rate. The cost of capital is 10%. If you expect the inflation rate to be 3% in the first year and 8% in the second year, what is the present value?

A) $930.58

B) $1,002.30

C) $1,030.68

D) $1,120.00

Answer 1

PV = [{Coupon Payment x (1 + Inflation 1)} / (1 + r)] + [{(Coupon Payment + Face Value) x (1 + Inflation 1) x (1 + Inflation 2)} / (1 + r)²]

= [($60 x 1.03) / 1.10] + [($1,060 x 1.03 x 1.08) / 1.10²] = $56.18 + $974.50 = $1,030.68

Hence, Option "C" is correct.