Securities Industry Essentials (SIE) ExamUnderstanding Products and Their RisksMedium
A client is concerned about inflation eroding the purchasing power of their fixed income investments. Which type of bond is specifically designed to protect against this risk?
- AMunicipal Bond
- BCallable Bond
- CZero-Coupon Bond
- DTreasury Inflation-Protected Security (TIPS)
Show answer & explanationAnswer & explanation
Correct answer: D. Treasury Inflation-Protected Security (TIPS)
Treasury Inflation-Protected Securities (TIPS) are U.S. Treasury bonds whose principal value adjusts with the Consumer Price Index (CPI), thus protecting investors from inflation.
Why the other options are wrong
- A. Municipal bonds offer tax advantages but do not inherently protect against inflation eroding principal or interest payments.
- B. Callable bonds have call risk (issuer can redeem early) and do not protect against inflation.
- C. Zero-coupon bonds are subject to reinvestment risk but do not offer direct inflation protection.
Treasury Inflation-Protected Securities (TIPS)
A type of U.S. Treasury bond that provides protection against inflation.
- Principal value adjusts with the Consumer Price Index (CPI).
- Coupon rate is fixed, but interest payments vary as principal adjusts.
- Offers protection against inflation risk.
Memory trick: TIPS Take Inflation's Punch, Protecting Principal.