Treasury Inflation Protected Securities (TIPS) are bonds issues by the US Treasu

Question

Treasury Inflation Protected Securities (TIPS) are bonds issues by the US Treasury that protects the investors against inflation. They have a much lower coupon rate, but the face value is indexed to inflation every coupon period. Hence, if you start with a face value of $1,000, and general level of prices tripled in 30 years, and your coupon rate is 1% APR, as your last payment, you will get $3,000 times 0.5% (semi-annual) which is $15 as coupon payment plus $3,000 as payment of the face value indexed for inflation. A regular bond pays only $1,000 as face value payment plus whatever the coupon maybe.

Currently, yields on regular Treasury Bonds for 10 and 30-year maturity are 2.90% and 3.05% respectively. The yields on TIPS with 10 and 30-year maturity are 0.80% and 0.94% respectively. Taking the difference gives for 10 and 30-year maturities gives 2.10% and 2.11%.

Controversial Claim Since the market essentially assuming that average rate of inflation will be about 2.10% for the next 30 years or so, we should BUY TIPS and SELL Regular Bonds. Claim

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Explanation / Answer

Refuting the Statement:

Since the difference between the Tips and Bonds for 10 and 30 year is 2.10% and 2.11% .Now to get profits fromTIPS one should be sure that the inflation for coming years should be more than 2.10 and 2.11% then only TIPS are profirtable than bonds. Now how can be that much sure that inflation will be more than 2.11 % ? What is the guarantee that inflation will be more than 2.11 % for 10 and 30 years?

So if the inflation is not above 2.11 % we are loosing coupons amount as the coupon payments are very less compared to bonds.

And TIPS is not suitable for retirement plans as the risk bearing capacity at that old age is very less.

Defending the statement:

Tips play an important role in diversified portfolio. It provides the necessary protection in Unexpected Inflation.If for suppose the inflation rose up more than 2.11 % then TIPS will come to your rescue. When interest rate rises bond prices falls. So in this situation TIPS will come to our rescue.

As TIPS will be inflation linked it will particularly useful in Real estate sector if rates shoot up.Tips is the only investmetnt that will help you for an unexpected inflation rise. So it is very important to have TIPS in your portfolio.

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