Judy Johnson is choosing between investing in two Treasury securities that mature in five years and have par values of $1,000. One is a Treasury note paying an annual coupon of 5.06 percent. The other is a TIPS which pays 3 percent interest annually. a. If inflation remains constant at 2 percent annually over the five years, what will be Judy’s annual interest income from TIPS bond?

Judy Johnson is choosing between investing in two Treasury securities that mature in five years and have par values of $1,000. One is a Treasury note paying an annual coupon of 5.06 percent while the other is a Treasury Inflation-Protected Security (TIPS) which pays 3% interest annually. If inflation remains constant at 2% annually over the five year period then Judy’s total annual interest income from her TIPS bond will be 7.06%.

The additional variable rate provided by TIPS bonds makes them more attractive to investors than traditional treasury notes under certain economic conditions; in this case with inflation remaining steady, Judy stands to benefit from receiving an extra 2% per annum compared to what she would receive from the treasury note. Furthermore these securities offer some protection against deflation as well; should prices suddenly fall Judy will still receive an above market rate for her investment.

Ultimately it all comes down to one’s individual circumstances and risk tolerance when deciding which option is best for them; however it can be argued that investing in TIPS can provide greater returns if inflation remains relatively stable or even falls while also providing some level of protection during periods of rising prices. Ultimately this type of security might be suitable for those looking for predictable returns over time with minimal risk exposure.