5-Year Treasury Inflation-Indexed Security
, Constant Maturity.
The value of an inflation-indexed security
(such as TIPS) tends to decrease when real interest rates increase, and increase when real interest rates decrease.
However, a large share of TIPS activity occurs via "breakeven inflation" trades, whereby a particular inflation-indexed security
is traded against a proportionate quantity of a particular nominal security.
5 percent, but there is an inflation risk associated with holding this bond that does not exist with an inflation-indexed security
such as TIPS.
Shen and Corning used a ten-year average inflation rate, and in their analysis, the maturity of the conventional Treasury security not always matched the maturity of the inflation-indexed security
that is, the expected rate of inflation at which the two securities trade at the same price--can be approximated by the difference in the yields to maturity between a nominal and an inflation-indexed security
An important real rate, which is thought to have a particular influence on investment spending, takes a common callable bond, the 30-year GNMA, and subtracts, as an inflation estimate, the yield difference between a 10-year Treasury bond and a 10-year Treasury inflation-indexed security
Example 1: A $100,000 face value inflation-indexed security
issued at par in January 2001 bears 5% interest and matures in four years.
This paper compares efficient portfolios containing an inflation-indexed security
to portfolios without such a security.
Because the payments automatically adjust to compensate for inflation, the yield on an inflation-indexed security
reflects the real rate of return that would be realized over the maturity of the security.
A final consideration in valuing TIIS is that the securities offer deflation protection, in the sense that the cumulative adjustment to the principal amount of the inflation-indexed security
at maturity cannot be negative.
This section describes the cash flows paid and received by a buy-and-hold investor in an inflation-indexed security