SIE practice questionmediumTIPS — Treasury Inflation-Protected Securities
How do Treasury Inflation-Protected Securities (TIPS) protect investors from inflation?
- ATIPS pay a variable interest rate tied to the federal funds rate
- BThe principal value is adjusted based on changes in the Consumer Price Index (CPI)✓ Correct answer
- CThe coupon rate increases with inflation
- DTIPS are exempt from all federal, state, and local taxes
Explanation
Why B — The principal value is adjusted based on changes in the Consumer Price Index (CPI)
TIPS protect against inflation by adjusting the principal (par value) based on changes in the CPI. The coupon rate remains fixed, but because it is applied to the inflation-adjusted principal, the dollar amount of interest payments rises with inflation. TIPS are subject to federal tax (C is wrong). The rate is fixed, not variable (D is wrong).
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