TIPS

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Definition: TIPS



What is the dictionary definition of TIPS?

Dictionary Definition


TIPS or Treasury Inflation-Protected Security is a special type of treasury note or bond that is protected from inflation. The principal and coupon payments are reflexively increased to counterbalance inflation as appraised by the Consumer price index (CPI). TIPS is regarded as one of the safest financial instruments.


Full Definition of TIPS


TIPS are Treasury Inflation-Protected Securities. As with other notes and bonds, holders of TIPS receive periodic interest payments and the return of their principal at the end of the term. What makes TIPS different from normal notes and bonds is that the return is automatically adjusted for inflation. Using the Consumer Price Index (CPI) as a benchmark, each TIPS interest payment is adjusted to reflect changes in the CPI. At the end of the term, there is a final adjustment to the principal returned to the TIPS holder.

TIPS are issued by the US Treasury and backed by the full faith and credit of the US government. Because TIPS are regarded as an extremely secure investment, they are popular with investors nearing retirement.

Value of TIPS is automatically adjusted to the CPI measured inflation. An inflationary increase of 1% will notch up the bond value by 1%. Fall of CPI, however, will not lead the value of TIPS to fall. This is due to the fact that government guarantees constancy of value of the bond. The disadvantage of TIPS is the low return it offers compared to other bonds.

The person who has invested in TIPS is paid original capital or inflation-adjusted capital-whichever is higher on maturity. The investor gets his interest payment semiannually at a fixed rate. TIPS are of three types differentiated according to their maturity period. These three types are 5-year TIPS, 10-year TIPS and 20 years TIPS. Interest accrued from TIPS is subject to federal tax. This bond is exempt from local and state taxes.

Inflation

It is the rate of increase in prices of services and goods over a period of time. Inflation is generally accompanied by a fall in purchasing power. Rise of inflation translates into a fall in purchasing power.

The Real Rate Of Return

It is the return on an investment every year expressed as a percentage. The return is adapted to inflation and other external effects. This economic method conveys the nominal rate of return in real terms, keeping the purchasing power of a specific quantum of capital constant over time. Investors adjust the nominal rate of return for factors like inflation. For example, an interest of 5% per annum on investment may practically be 3% if the inflation rate is 2%. Thus, an investor gets only 2% interest on his investments every year.


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Definition Sources


Definitions for TIPS are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 29th March, 2020 | 2 Views.