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Finance Dictionary and Glossary of Investment Terms
CPI-Indexed Treasury Notes (TIPS)
Definition 1.
A series of inflation-adjusted 10-year notes first issued by the US Treasury in 1997. The Treasury hopes that these offerings will save taxpayers money by attracting more demand for Treasuries through a better mix of offerings.The 10-year notes attempt to protect investors from inflation by linking the principal payment to CPI. The interest payment is constant over the 10 years, probably in the neighborhood of 3.5%. What changes is the principal. Each year, the principal is increased by the same percentage that CPI increases during the prior year. The interest payment, not the rate, increases as well, since the amount of the principal has increased commensurate with the CPI increase. Of course, investors will not see any of the increase in principal until the maturity of the note.Herein lies one of the drawbacks of the new notes. The IRS requires that you pay taxes each year on the interest payment and on the increase in principal. You will not see the inflation adjustment on the principal until the maturity of the notes, but you will pay tax on it now. If inflation were quite high for several years, the tax payments could potentially exceed the interest payments.
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