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Question of the Week - Fixed Income
Erin purchases a ten-year TIPS bond with a $25,000 face value. This particular issue pays semiannual coupons at a rate of the CPI + 125 basis points, with a floor of 5%.
CPI rates for the first three reset dates are 3.25%, 4.75%, and 5.25%.
The payout from this bond over the first three coupons is closest to?
Question of the Week - Fixed Income 19 votes
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Comments
The first coupon rate is 3.25% + 1.25% = 4.50%. That rate is floored up to 5.00%. The semiannual coupon payment is 5.00% * $25,000 * 0.5 = $625. (Remember that as these are semiannual coupons; the actual payment is half the annual amount.)
The second coupon rate is 4.75% + 1.25% = 6.00%. (The floor does not affect this rate.) The semiannual coupon payment is 6.00% * $25,000 * 0.5 = $750.
The third coupon rate is 5.25% + 1.25% = 6.50%. (The floor does not affect this rate either.) The semiannual coupon payment is 6.50% * $25,000 * 0.5 = $813.
The total payout then is $625 + $750 + $813 = $2,188.
It's slightly more than 2,200. It would be the same answer anyway.