Marcel Benjamin is back on the show for another appearance to dig into the details around TIPS Bonds (Treasury Inflation Protected Securities). How they work and why they are misunderstood by many. Plus, we discuss interest rate risk comparing high and low interest rate environments. Yup, even a little bond convexity primer! This was a great conversation that gives anyone a much greater depth of knowledge on an asset class that is a little more complicated.

T Bonds and Bills: lower interest rates, increased duration and sensitivity to changes in interest rates Examples of potential changes in market value (risk) when interest rates go up or down Its about looking at the series of cash flows What are TIPS (Treasury Inflation Protected Securities) Bonds? How are TIPS Bonds designed to be adjusted for inflation based on the CPI? Size of the TIPS Bond market Primary risks include interest rate changes and deflation. Breakeven rates a view into market view on inflation 5-Year/ 5-Year Forward Rates Auctions going off at negative yield to maturity Comparing 2020 to 2008 break evens Bond Convexity primer Mortgage bonds unique convexity due to pre-pays by homeowners Duration over the years on the US AGG (Aggregate Bond) Index

Mentioned in this Episode:

Marcel Benjamin’s prior podcast appearance covering High Yield Bonds

Information on State Street Global Advisors SPDR fixed income products

Contact Derek Moore derek.moore@zegafinancial.com

Derek Moore’s Book Broken Pie Chart …(read more)

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TIPS inflation-protected bonds are a specialized type of government bond that offers protection against inflation. TIPS stands for Treasury Inflation-Protected Securities, and they are issued by the U.S. Department of Treasury. These bonds are designed to help investors preserve the purchasing power of their money in times of rising prices.

Unlike traditional bonds, TIPS have their principal adjusted for inflation. This means that the value of the bond increases with inflation, and so does the interest payments. This protection ensures that investors do not suffer losses in real terms due to inflation.

Interest Rate Risk and Duration in TIPS

While TIPS bonds offer inflation protection, they are not without risks. One of the major risks associated with TIPS is interest rate risk. Like any other bond, TIPS are subject to fluctuations in interest rates, which can affect their market value. When interest rates rise, the value of existing bonds decreases. This is because investors can purchase new bonds with higher coupon rates, making existing bonds less attractive.

Duration is an important concept in understanding interest rate risk. Duration measures the sensitivity of a bond’s price to changes in interest rates. TIPS typically have longer durations compared to traditional bonds because their interest payments are adjusted for inflation. As a result, TIPS are more sensitive to changes in interest rates.

It is crucial for investors to be aware of the interest rate risk and the duration of TIPS before investing. Understanding how changes in interest rates can affect the value of their investment can help them make informed decisions.

Other Considerations for TIPS

In addition to interest rate risk, investors should consider several other aspects before investing in TIPS. Firstly, they should evaluate their risk tolerance and investment objectives. TIPS may not be suitable for all investors, especially those seeking higher returns or have a lower risk tolerance.

Secondly, investors should consider the prevailing inflation environment. TIPS can provide better returns during periods of high inflation. However, during periods of low inflation, other investment options may offer greater returns.

Finally, it’s important to note that TIPS are subject to federal income taxes, but exempt from state and local taxes. This tax treatment can have implications for investors in high-tax jurisdictions.

Conclusion

TIPS inflation-protected bonds are a unique investment option that provides protection against inflation. They can be an effective tool for preserving purchasing power and diversifying investment portfolios. However, it’s important to understand the interest rate risk and duration associated with TIPS before investing. Considering personal investment goals and having a thorough analysis of the prevailing economic conditions can help make informed decisions about investing in TIPS.