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Thursday, 30 August 2012

TIPS would eventually increase in real value during deflation


TIPS would eventually increase in real value during deflation

The statement

“When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater,”

has the following results:

During inflation in the US

TIPS principal’s nominal value increases with inflation: its real value is thus maintained constant.

During initial deflation in the US with the adjusted (decreased) principal still greater than the original principal

TIPS principal’s nominal value decreases with deflation: its real value would thus be maintained constant during the initial period of deflation.

During subsequent deflation in the US with the adjusted principal less than the original principal

TIPS principal’s original nominal value would be maintained constant during subsequent deflation: its real value would thus increase during subsequent deflation. This would be a costly process for the US government.

UK, Canada and Japan

‘The UK, Canada and Japan, do not guarantee a minimum redemption price for their indexed issues.’
Comité de Normalisation Obligataire 2011: 15

The capital amounts of UK, Canadian and Japanese sovereign inflation-linked bonds would thus maintain their real values constant at all levels of inflation and deflation.
 
 
 
 
Nicolaas Smith


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