Definition
TIPS provide inflation protection by adjusting the principal value with CPI changes. The coupon rate is fixed but applied to the inflation-adjusted principal, so both coupon payments and final principal increase with inflation. The real yield (TIPS yield) versus nominal Treasury yield reveals the market's inflation expectations (breakeven inflation rate).
functions Formula
Breakeven Inflation = Nominal Treasury Yield − TIPS Yield
lightbulb Example
A 10-year TIPS has 1.5% real yield. The 10-year nominal Treasury yields 4.3%. Breakeven inflation = 2.8%. If actual inflation exceeds 2.8%, TIPS outperform nominals.
verified_user Key Points
- Principal adjusts with CPI
- Coupon rate is real (inflation-adjusted)
- Breakeven inflation reveals market expectations
- Deflation floor protects principal at maturity