Suppose the rate of return on a 10-year T-bond is currently 5.00% and that on a 10-year Treasury Inflation Protected Security (TIPS) is 2.10%. Suppose further that the maturity risk premium on a 10-year T-bond is 1.0%, that no maturity risk premium is required on TIPS, and that no liquidity premiums are required on any T-bonds. Given this data, what is the expected rate of inflation over the next 10 years

Multiply your original principal amount by the Index Ratio. This is your inflation-adjusted principal. Multiply your inflation-adjusted principal by half the stated coupon rate on your security (i.e., 2%). The resulting number is your semi-annual interest payment.The principal value of an inflation-protected bond is adjusted upward or downward based on changes in the Consumer Price Index, which is the formal measure of inflation in the United States. Inflation protected bonds pay a fixed rate of interest twice a year.

Explanation:

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