Treasury Inflation-Protected Securities (TIPS)
Chapters in this video
- 0:00 What TIPS are: U.S. government debt specs and CPI-U thermometer
- 1:50 The sponge principal: how inflation grows the base
- 2:55 The coupon rate is fixed: exam trap number one
- 3:38 Concrete math: $10.30 semiannual payment example
- 4:17 Deflation floor at maturity only: exam trap number two
- 5:17 Phantom income: the IRS taxes the ghost
- 6:18 Suitability: tax-deferred account as the right answer
- 7:26 Rapid-fire exam recap
What this video covers
- Why the Consumer Price Index for All Urban Consumers (CPI-U) adjusts the principal of a Treasury Inflation-Protected Security (TIPS), not its coupon rate
- How to calculate the semiannual interest payment using the adjusted principal: fixed annual rate divided by 2, then multiplied by the inflation-adjusted base
- The exam distinction between the fixed coupon rate and the variable coupon dollar amount, and why the rate never floats
- Where the deflation floor applies at maturity (greater of adjusted principal or original par) and why it does not protect interest payments during the bond's life
- What phantom income is on TIPS: the annual principal increase taxed as ordinary income despite no cash received until maturity or sale
- Why TIPS are best suited for tax-deferred accounts such as individual retirement accounts (IRAs) or 401(k)s to avoid annual phantom taxation
- How TIPS interest is federally taxable as ordinary income but exempt from state and local tax, consistent with all U.S. Treasury securities
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