Which statement about Treasury Inflation-Protected Securities is true?

Which statement about Treasury Inflation-Protected Securities is true?

• A. They are risk-free standard bonds with no principal adjustment
• B. They pay fixed coupons regardless of inflation
• C. Coupon payments increase or decrease with inflation
• D. They have no inflation protection

Answer: (C)

TIPS provide inflation protection by tying the principal to the CPI. The coupon payments are calculated by applying a fixed coupon rate to that inflation-adjusted principal. When inflation rises, the principal increases, so the dollar amount of each coupon payment rises; when there’s deflation, the principal can decrease, and coupon payments fall. The rate is fixed, but the actual payments move with inflation because they’re based on the inflation-adjusted principal. This is why the statement about coupon payments increasing or decreasing with inflation is true. The other ideas—no principal adjustment, fixed coupons regardless of inflation, or no inflation protection—don’t fit how TIPS actually work.

TIPS provide inflation protection by tying the principal to the CPI. The coupon payments are calculated by applying a fixed coupon rate to that inflation-adjusted principal. When inflation rises, the principal increases, so the dollar amount of each coupon payment rises; when there’s deflation, the principal can decrease, and coupon payments fall. The rate is fixed, but the actual payments move with inflation because they’re based on the inflation-adjusted principal. This is why the statement about coupon payments increasing or decreasing with inflation is true. The other ideas—no principal adjustment, fixed coupons regardless of inflation, or no inflation protection—don’t fit how TIPS actually work.