Judy Johnson is choosing between investing in two Treasury securities that both mature in five years and have par values of $1,000. One is a Treasury note paying an annual coupon of 5.06 percent. The other is a TIPS which pays 3 percent interest annually.
a) If inflation remains constant at 2 percent annually over the next five years what will be Judy’s annual interest income from the TIPS bond? From the Treasury note?
b) How much interest will Judy receive over the five years from the Treasury note? From the TIPS?
c) When each bond matures, what par value will Judy receive from the Treasury note? The TIPS?
d) After five years, what is Judy’s total income (interest + par) from each bond? Should she use this total as a way of deciding which bond to purchase?