GetSmarter wrote: ↑Sun Jun 19, 2022 9:06 pm Do I understand correctly:
1) There is a coupon paid out twice a year based on a small rate that doesn't change for the duration of bond.
The coupon fixed rate doesn't change, but it is multiplied by the index ratio (inflation factor) for the coupon payment dates. So the semi-annual coupon amount is face value * coupon rate / 2 * index ratio.
If inflation is greater than 0% for the holding period, the inflation-adjusted principal amount will be greater than the principal paid at purchase, because the index ratio (IR) will be greater than 0. Remember, the IR is the reference CPI for the date of interest divided by the dated date reference CPI. The former will be greater than the latter if inflation is greater than 0%.GetSmarter wrote: ↑Sun Jun 19, 2022 9:06 pm 2) In addition, the principal amount at maturity will reflect a greater number than the original par purchase value IF inflation was greater than ? for a period of time within the 4 years 10 months (of upcoming auction TIP).
GetSmarter wrote: ↑Sun Jun 19, 2022 9:06 pm Can you explain what kind of inflation rate will make TIPS a valuable investment.
It is a valuable investment at any inflation rate if your goal is to earn about the real yield at purchase, and you plan to hold to maturity. If inflation is greater than 0% for the holding period, your annualized return will be about the original real yield, with the uncertainty depending on what rates the coupons are reinvested (if at all). If there is net deflation over the holding period, your real return will be higher than the initial real yield, because the adjusted price cannot fall below 100 at maturity.
I think this already is answered above.GetSmarter wrote: ↑Sun Jun 19, 2022 9:06 pm For example, inflation just went higher and fed rate went higher too in order to try and bring down inflation. If inflation numbers start coming down from where we bought at, are TIPS potentially still paying higher than principal because inflation didn't hit a certain floor. What would that floor be?
GetSmarter wrote: ↑Sun Jun 19, 2022 9:06 pm If I believe inflation will come down within a few years but still believe it will be greater than 2 or 3 %, will I be compensated for holding my money in long-term TIPS?
You will earn about the original yield if held until maturity, regardless of what happens to inflation, unless there is deflation, as explained above.
Since the seasonally adjusted breakeven inflation rate (SA BEI) is less than 3% for terms beyond the 10/15/2025 TIPS, you will earn a higher nominal return on these TIPS than on nominal Treasuries of same maturities if average inflation is greater 3%.
Conversely, the SA BEI on the longest term TIPS is about 2.4%, so your longest-term nominal Treasury would earn more than this TIPS if inflation averages less than 2.4% over the next 30 years.
If your goal is to keep up with inflation, then TIPS with positive real yields are the way to go. With nominal Treasuries, your real return depends on inflation, which is unknown.GetSmarter wrote: ↑Sun Jun 19, 2022 9:06 pm I hope I asked my questions well. The language is very new for me. I'm trying to figure out my odds for keeping up with inflation if I buy TIPS vs Nominal Treasuries. I could do both, like you mentioned you do. I just hoped to understand TIPS and the risks I may be taking in our volatile environment. My goal is preservation of capital with income.
Kevin