NASAA Series 65, Uniform Investment Adviser Law ExaminationInvestment Vehicle CharacteristicsEasy
A client is concerned about the impact of inflation on their fixed-income portfolio and is looking for a debt security designed to protect against a loss of purchasing power. Which of the following investments would be most suitable?
- ATreasury Inflation-Protected Security (TIPS)
- BTreasury Bond
- CMunicipal Bond
- DCorporate Bond
Show answer & explanationAnswer & explanation
Correct answer: A. Treasury Inflation-Protected Security (TIPS)
Treasury Inflation-Protected Securities (TIPS) are explicitly designed to protect investors from inflation by adjusting their principal value based on the Consumer Price Index (CPI).
Why the other options are wrong
- B. Treasury Bonds offer fixed interest payments but do not adjust for inflation, making them vulnerable to purchasing power erosion.
- C. Municipal Bonds offer tax-exempt interest but do not adjust their principal or interest payments for inflation.
- D. Corporate Bonds offer fixed interest and are subject to inflation risk, similar to other traditional fixed-income securities.
Treasury Inflation-Protected Security (TIPS)
A U.S. Treasury bond that is indexed to inflation to protect investors from the erosion of purchasing power.
- Principal value adjusts semi-annually based on the Consumer Price Index (CPI).
- Coupon rate is fixed, but interest payments vary as they are applied to the adjusted principal.
- At maturity, investors receive the greater of the original or adjusted principal.
- Provides a hedge against inflation.
Memory trick: TIPS: Treasury's Inflation Protection Shield.