[JOELOCKABY]

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
Next five years, what will be Judy's annual interest income
From the TIPS bond? From the Treasury note?
If inflation over the next five years is 2%, the principle value rises to $1000 plus 2% or $1,020. The effective interest, what we are effectively earning on the tips with the inflation, is 5.06% - 2% = 3.06%. Judy's annual interest income from the TIPS bond = 1000 x 0.02 x 5 = $100
Judy's annual interest income from the TIPS bond
First year: value: 1020 interest 30.6
Second year: value: 1040.4 interest: 31.21
Third year: value: 1061.21 interest: 31.84
Fourth year value: 1082.43 interest: 32.47
Fifth year value: 1104.08 interest: 33.12

Judy's annual interest income from the Treasury note
First year: value: 1020 interest 51.61
Second year: value: 1040.4 interest: 52.64
Third year: value: 1061.21 interest: 53.70
Fourth year value: 1082.43 interest: 54.77
Fifth year value: 1104.08 interest: 55.87

B. How much interest will Judy receive over the five years from
The Treasury note? From the TIPS?
Interest from Treasury note: 205.76
Interest The TIPS: 333.95

C. When each bond matures, what par value will Judy receive
From the Treasury note? The TIPS? If the bond matures 3 %, then Judy should receive a value of $30.00
$.03 % x $1,000 = $30.00

D. After five years, what is Judy's total income (interest par)
From each bond? Should she use this total as a way of deciding
Which bond to purchase?