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Series 7 practice questionmediumDebt Securities — US Government — TIPS

Treasury Inflation-Protected Securities (TIPS) protect investors against inflation by adjusting:

  1. AThe coupon rate semi-annually based on the CPI
  2. BThe principal value based on changes in the Consumer Price Index (CPI), while the coupon rate remains fixed✓ Correct answer
  3. CBoth the principal and coupon rate based on the Federal Funds rate
  4. DThe maturity date based on inflation expectations
Explanation

Why B — The principal value based on changes in the Consumer Price Index (CPI), while the coupon rate remains fixed

TIPS adjust the principal value based on changes in the Consumer Price Index (CPI). The coupon rate remains fixed, but because it is applied to the inflation-adjusted principal, the actual dollar amount of interest payments increases with inflation. At maturity, the investor receives the greater of the adjusted principal or original par value, protecting against both inflation and deflation.

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