Question: Consider a TIPS security paying 1% inflation-adjusted coupon annually. The bond currently has T = 10 yrs. to maturity, and is currently priced at par.

Consider a TIPS security paying 1% inflation-adjusted coupon annually. The bond currently has T = 10 yrs. to maturity, and is currently priced at par. Assume that, one-yr. from now, the inflation rate was 2%. Prior to the computation of the annual coupon payment, the bond’s principal value will be indexed upwards by 2% (to $102).

1. What is the annual coupon payable one year from today?

2. what is the ex-coupon price of the bond? (real rates remained unchanged)

3. Explain the intuition of the bond’s ex-coupon value one year Hence.

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