FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client is looking for an investment that provides income and potential for capital appreciation, but is concerned about inflation eroding purchasing power. Which of the following debt securities would be most suitable for this client?
- ATreasury Inflation-Protected Security (TIPS)
- BZero-Coupon Bond
- CHigh-Yield Corporate Bond
- DMunicipal Bond
Show answer & explanationAnswer & explanation
Correct answer: A. Treasury Inflation-Protected Security (TIPS)
Treasury Inflation-Protected Securities (TIPS) are designed to protect investors from inflation. Their principal value adjusts semi-annually based on changes in the Consumer Price Index (CPI), and the interest payments are then calculated on this inflation-adjusted principal.
Why the other options are wrong
- B. Zero-coupon bonds do not provide current income and are highly sensitive to interest rate changes, offering no direct inflation protection.
- C. High-yield corporate bonds offer higher income but come with significant credit risk and do not offer direct protection against inflation.
- D. Municipal bonds offer tax-exempt income but do not have features that specifically protect against inflation.
Treasury Inflation-Protected Securities (TIPS)
Debt securities issued by the U.S. Treasury that provide protection against inflation. Their principal value adjusts with the Consumer Price Index (CPI), and interest payments are made on the adjusted principal.
- Principal adjusts with CPI.
- Interest rate is fixed, but interest payments vary with principal.
- Phantom income is a potential tax consideration.
Memory trick: TIPS are your 'Inflation Protection Shield' for government bonds.