Treasury Inflation-Protected Securities (TIPS)
Also known as: TIPS
Treasury Inflation-Protected Securities (TIPS) are US government bonds whose principal adjusts with inflation as measured by the Consumer Price Index. The fixed coupon rate is applied to the adjusted principal, so interest payments rise with inflation.
Treasury Inflation-Protected Securities (TIPS) are marketable US Treasury bonds designed to shield investors from inflation risk, also called purchasing power risk. Unlike a conventional Treasury note or bond, a TIPS has a principal value that is adjusted up or down based on changes in the Consumer Price Index (CPI).
The mechanics are straightforward. A TIPS pays a fixed coupon rate, but that rate is applied to the inflation-adjusted principal. Suppose an investor holds a $1,000 TIPS with a 2% coupon and inflation runs 3% for the year: the principal adjusts to roughly $1,030, and the 2% coupon is now paid on that larger amount. When inflation rises, both the principal and the dollar value of each interest payment increase. In a deflationary period the principal adjusts downward, but at maturity the investor receives the greater of the adjusted principal or the original face value.
TIPS matter because ordinary fixed-rate bonds lose purchasing power when inflation runs high — their fixed payments buy less over time. TIPS remove most of that risk, which is why their stated coupon rates are lower than those of comparable conventional Treasuries. The trade-off: investors give up some yield in exchange for inflation protection, and the annual principal adjustments are taxable federally even though they are not received in cash until maturity.
The SIE, Series 7, and Series 65 exams all test TIPS within US government debt and risk material. Know that the principal (not the coupon rate) adjusts with CPI, that TIPS protect against inflation/purchasing power risk, and that at maturity the holder never receives less than original par.
Key takeaways
- TIPS are US Treasury securities whose principal adjusts with inflation as measured by the CPI.
- The coupon rate stays fixed, but it is applied to the adjusted principal, so interest payments rise with inflation.
- At maturity, investors receive the greater of the inflation-adjusted principal or the original face value.
- TIPS are the classic answer to purchasing power (inflation) risk on securities exams, and they yield less than comparable conventional Treasuries in exchange for that protection.