Q1. The annual coupon rate for a TIPS is 6%. Suppose that an investor purchases $1,000 of par
value (initial principal) of this issue today and that the annual inflation rate is 3%. (10 points)
1. What is the dollar coupon interest that will be paid in cash at the end of the first six months?
2. What is the inflation-adjusted principal at the end of the year?
3. Suppose that an investor buys a five-year TIP and there is deflation for the entire period.
What is the principal that will be paid by the Department of the Treasury at the maturity date?
Q2. Suppose that the price of a Treasury bill with 60 days to maturity and a $1 million face
value is $990,000. What is the yield on a bank discount basis? (10 points)
Q3. Investors largely anticipated that the FOMC would announce tapering off its bond-buying
(QE3) program at the end of the FOMC meeting on September 18, 2013. The FOMC surprised
the financial market by indicating no taper for at least another month. How did stock and bond
markets react to the FOMC announcement and why? What are the rationales for the FOMC
policy action? (Hint: read the FOMC statement at the link
http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm) (10 points)
Q4. The chart below plots the yield to maturity for the 10-year nominal Treasury bond (solid
line) and 10-year TIPS (dashed line) over the January 2003 to August 2013 period. Explain why
the nominal bond always has a higher yield than the TIPS. Does the yield spread between the
nominal bond and the TIPS tell us anything about future inflation rate? Discuss. (10 points)