Judy Johnson is choosing between investing in two Treasury securities that 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 five years, what will be Judy’s annual interest income from TIPS bond?

Judy Johnson must choose between buying two Treasury Securities with par values of $1000 that are due to mature five years from now. The Treasury Note pays an annual interest rate of 5.06 per cent, while the Treasury Inflation Protected Security (TIPS), which is paid 3% annually by Treasury Inflation Protected Security (TIPS), has a coupon that is only 5.06 per cent. If inflation remains constant at 2% annually over the five year period then Judy’s total annual interest income from her TIPS bond will be 7.06%.

In certain conditions, TIPS bonds are more appealing to investors than traditional Treasury notes. For example, if inflation remains constant in the case of Judy’s situation and she receives an additional 2% annually compared to her treasury bill. Additionally, these securities provide some protection against the deflation. Should prices drop suddenly Judy’s investment will receive a rate above market.

Ultimately it all comes down to one’s individual circumstances and risk tolerance when deciding which option is best for them; however it can be argued that investing in TIPS can provide greater returns if inflation remains relatively stable or even falls while also providing some level of protection during periods of rising prices. Those who are looking to earn predictable returns in the long term with minimal risks may find this security attractive.