Treasury inflation-protected securities or tips, Financial Management

Assignment Help:

Treasury Inflation-Protected Securities (TIPS) are the inflation-indexed bonds, the US Treasury offers. The first offer was made in the year 1997. As the name suggests, it offers protection from inflation. In this type of securities, the interest is paid every six months and the principal amount at the time of maturity. These are normally offered in 5-year, 10-year and 20-year maturities. The specific difference between TIPS and other types of treasury securities is that the coupon amount and the outstanding principal amount in TIPS gets automatically increased to compensate for inflation as measured by the Consumer Price Index (CPI).

CPI is an index used for measuring inflation. The principal amount of TIPS gets adjusted to the CPI so that the purchasing power of the investor is not affected due the inflation. Though the coupon rate is constant in the case of TIPS, it still provides an interest amount which is duly multiplied by the inflation-adjusted principal. Thus, it is evident that TIPS protects its investors against inflation.

The US treasuries are considered safe investments. Of all these securities, TIPS are considered the safest treasury securities. The reason is that investors in TIPS get the rate of return duly compensated with the increase in inflation rate. This means the rate of return representing the growth of purchasing power is guaranteed. Due to this feature, it offers a low rate of return to its investors.

The interest payable on TIPS is taxable as per federal income tax laws in the year of receipt of such interest amount. The amount credited as an adjustment against inflation is also taxable every year. This tax treatment projects that the amount generated by this type of security is inversely related to inflation till the security reaches its maturity. In simple terms, when there exists no inflation then the amount generated may be exactly the same as for a normal bond. The investor receives the coupon amount less the taxable amount on the coupon amount. Similarly, where there is inflation the investor receives the coupon amount as per CPI less the taxable amount on the Coupon amount. Here, the investor has to pay an additional tax on the inflation adjusted principal.               


Related Discussions:- Treasury inflation-protected securities or tips

Yield curve strategies, Yield curve strategies take into account the ...

Yield curve strategies take into account the distribution of the maturities of the bonds of the portfolio in order to take advantage of the forecasted movements o

Seasonal variation in time series analysis, Seasonal Variation Under th...

Seasonal Variation Under this variation, we observe that the variable under consideration shows a similar pattern during certain months of the successive years. An example of s

Capital budget relate to pro forma financial statements, Explain how the ca...

Explain how the cash budget and the capital budget relate to pro forma financial statements. The cash budget demonstrates the projected flow of cash in and out of the firm fo

Role of Trustee in Pension Fund, Role of Trustee in Pension Fund: Trust...

Role of Trustee in Pension Fund: Trustees are people in control of long-term asset allocation of a pension scheme. Whatever benchmark they set will, as we shall see, influence

Cash flow matching, Cash flow matching strategy is used to build a ...

Cash flow matching strategy is used to build a bond portfolio wherein the cash flows of the bond portfolio exactly match a stream of liabilities. The most s

Advantage of profitability index method, Q. Advantage of Profitability Inde...

Q. Advantage of Profitability Index method? Advantage of PI method:- (i) Similar to the other DCF techniques the PI method as well takes into account the time value of money

Valuation methods, Valuation Methods: 2 - Year Method Perpetual ...

Valuation Methods: 2 - Year Method Perpetual Growth Method Constant Growth Method Zero Growth Method Growth Phases Valuation Model:  'Constant Growth Met

What is business risk, What is Business risk It is related to response ...

What is Business risk It is related to response of the firm's earnings before taxes andinterest, or operating profits, to changes in sales. When cost of capital is used to eval

Explain about temporary or variable working capital, Q. Explain about Tempo...

Q. Explain about Temporary or Variable Working Capital ? Temporary or else Variable Working Capital - Any amount over and above the permanent level of working capital is called

Return on common equity finance basics, At the end of the fiscal year endin...

At the end of the fiscal year ending June 30, 2003, Microsoft reported common equity of $64.9 billion on its balance sheet, with $49.0 billion invested in financial assets (in the

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd