What are Treasury inflation-protected securities (TIPS)?

Treasury inflation-protected securities (TIPS) are US Treasury notes and bonds that pay a fixed rate of semiannual interest over their life on their principal value adjusted for changes in the consumer price index (CPI) and redeemed at maturity at the greater of their inflation-adjusted or original principal value.  TIPS are inflation-linked securities that pay interest at a fixed rate applied to the principal adjusted for changes in inflation as indicated in the consumer price index (CPI).  TIPS are issued with terms of 5, 10 and 30 years, in increments of $100 and at an interest rate determined at auction.

The interest rate is a fixed at auction and the amount of each semiannual interest payment is determined by multiplying the adjusted principal by one-half the annual interest rate.  The TIPS inflation index ratio shows the change to principal resulting from changes in the consumer price index (CPI) and is used to determine the inflation-adjusted semiannual interest payment.

Some of the advantages of investing in TIPS are:

• They are considered free of credit risk, since they are debt obligations of the US Treasury;
• Their inflation adjustments provide better price protection than conventional bonds when rates are rising as a result of increasing inflation; and
• They can be an effective portfolio diversification tool, since they have a low correlation with other types of investments.

Unlike US TIPS, Canadian TIPS have a floor on the inflation-compensation mechanism, such that the principal cannot decline below the original issue amount in the event of deflation.  Inflation-protected bonds (IPBs) are commonly issued by governments around the world.