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Friday, 2 December 2011

TIPS are nominal bonds during deflation: better investments than during inflation


TIPS are nominal bonds during deflation: better investments than during inflation

      The 6-monthly TIPS coupon payments are inflation- and deflation-adjusted; i.e., they are maintained at their real interest rates during inflation and deflation.
      The principal is repaid at maturity. If the nominal value of the principal is lower than the issuance value due to deflation, then the nominal issuance value will be repaid. The principal is thus inflation-indexed during inflation, but, it is a nominal bond during deflation; i.e., it is not deflation-adjusted for repayment purposes, only in order to calculate the constant real interest rate during inflation and deflation. The TIPS principal will gain real value during deflation since it will be repaid at its nominal issuance value.
     True to its name, the Treasury Inflation-Protected Security´s principal or capital amount is protected against the risk of losing real value during inflation. Additionally, the principal also gains in real value during deflation. TIPS are nominal bonds with a constant real interest rate or coupon payments during deflation.
     The TIPS principal gains in nominal value during inflation (its real value stays the same) while it gains in real value (its nominal value stays the same) during deflation. TIPS coupon payments stay the same in real value during inflation and deflation. TIPS are thus worth more in real value during deflation than inflation. TIPS are better investments during deflation than inflation. TIPS are inflation-protected and deflation-enriched with constant coupon payments.



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