Treasury Inflation Protected Securities
Treasury Inflation Protected Securities or TIPS are securities which have a principal that is tied to the Consumer Price Index (CPI). With inflation, the principal increases. With deflation, it decreases. When the security matures, the U.S. Treasury pays the original or adjusted principal, whichever is greater.
The coupon rate on TIPS is fixed, and TIPS pay interest every six months based on a fixed rate applied to the adjusted principal. Each interest payment is calculated by multiplying the adjusted principal by one-half the interest rate.
TIPS offerings include 5-year, 10-year and 20-year maturities.Newly issued TIPS can be purchased without any fee in the months that they are auctioned directly from the government through its TreasuryDirect program. They can also be bought through a bank, broker, or dealer.
The TIPS market, which was authorized in 1997, has the following benefits, according to a presentation given by William C. Dudley, the executive vice president of the markets group at the Federal Reserve Bank of New York in 2007:
- Greater diversification of the Treasury’s funding sources, which presumably has favorable implications for the Treasury’s funding costs;
- The potential for TIPS issuance to reduce the variability of the U.S. government’s net financial position;
- Access to a market-determined measure of inflation expectations that can help inform the conduct of monetary policy and
- The provision of a virtually risk-free investment that provides value to risk-averse investors.
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- Features and Risks of Treasury Inflation Protection Securities. Federal Reserve Bank of Kansas City.