More on TIP Yields

Arnold Kling comments on the high short-term TIP yields:

The overall return on a seasoned TIP consists of three things. First, there is the coupon on the security. Second, there is the appreciation or depreciation of price. Third, there is the change in the accrued inflation factor. The coupon on the 1/15/09 TIP is 3.875 percent, so interest accumulates at that annual rate between now and then. So you can expect about 0.5 percent in interest (taking the number of days between now and January 15th, dividing by 365, and multiplying by the coupon rate). The price this morning was roughly 98.35, and if you hold it until January 15th it will effectively go to 100. So, you have a 1.65 percent gain from that. Annualize that number, and there’s your double-digit yield.
The catch concerns the accrued inflation factor. Because the bond has been outstanding for almost ten years, the accrued inflation factor as of December 1st is 1.33 and headed down, because of the decline in the Consumer Price Index in October, to 1.32 on December 31 or a little less than a one percent drop.
I am guessing that the inflation factor for January 1st through 15th depends on the November CPI. If the November CPI declines by, say, one percent, then my guess is that the inflation factor would decline by another 0.5 percent. If that happens, then by my calculation your yield will be 0.5 + 1.65 – 1.5 = 0.65, over a period of roughly 50 days. At an annual rate, it is something just over 4.5 percent. Nice for a short-term Treasury, but nothing like double digits.
On the other hand, if we get an enormous drop in the CPI (keep in mind that gas prices are certainly going to be lower), you could actually lose money. If I’m doing the arithmetic right, with a 2.3 percent drop in the CPI, the accrued inflation factor would go down another 1.15 percentage points, and your total yield would be zero.

Posted by on November 26th, 2008 at 12:20 pm

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