INFLATION-INDEXED BONDS IN THE UNITED STATES

question 103

Multiple Choice

INFLATION-INDEXED BONDS IN THE UNITED STATES
Are there bonds that can protect your investments from inflation?
In 1997, the U.S. Department of the Treasury created a new financial instrument called the Treasury Inflation-Protected
Security, or TIPS. The key feature of TIPS is that the payments to investors adjust automatically to compensate for the actual
changes in the Consumer Price Index. Therefore, TIPS provide protection to investors from inflation.
Like other government bonds, TIPS make interest payments every six months and a payment of the original principal when
the bond matures. However, unlike other Treasury bonds, these payments are automatically adjusted for changes in inflation.
Despite their obvious attractions, the market for TIPS is still rather small. As of 2005, there were about $200 billion in TIPS
outstanding, compared to a total volume of about $4 trillion ($4,000 billion) total Treasury obligations. Because TIPS
compensate for actual inflation, the interest rate on these bonds differs from conventional bonds by the expected inflation
rate. By comparing the interest rates on TIPS to other government bonds of similar maturity, economists can estimate the
public’s expectations of inflation.
SOURCE: Simon Kwan, "Inflation Expectations: How the Market Speaks," Federal Reserve Bank of San Francisco Economic
Letter, October 7, 2005.
-According to the application, an investor would find TIPS most advantageous if:

• A) the economy experiences small large fluctuations in the inflation rate.
• B) the economy experiences small fluctuations in the unemployment rate.
• C) the economy experiences large fluctuations in the inflation rate.
• D) the economy experiences large fluctuations in the unemployment rate.

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