American Treasury Inflation-Protected SecuritiesBond Instruments
Treasury Inflation-Protected Securities are commonly referred to as “TIPS” in shorthand. These are secondary market tradable, which is different than Inflationary Savings Bonds. Treasury Inflation-Protected Securities are not registered to the purchaser via social security number or any other means, and can be transferred from seller to buyer. You can purchase and sell them in the secondary security markets. TIPS are issued via banks, brokers, and the US treasury.
Initial sales of Treasury Inflation-Protected Securities use an auction format. The auction format comes with competitive and noncompetitive bidding types. The first bid type is the non-competitive bid, which purchases the bond according to the yield currently available at the auction. In exchange, you get the TIPS and the full amount of par value desired. If you are offering a noncompetitive bid, you can purchase the bond directly from the government.
The second bid type is the competitive bid, which is not guaranteed to deliver a security at all. If you wish to make a competitive bid, you will need a bank, dealer, or broker who will participate in the auction for you. In the competitive bid, you bid the yield you want to receive from your TIPS bond. If successful, you will receive the TIPS with the bond at full par value and your yield. Since you are offering what they’re going to be paying you, it is their option to accept or reject the offer. It’s in their best financial interest to pay less.
If you make an offer to government to pay a yield less than the current yield offers, your bid is accepted and you will receive a bond at exactly the par value you requested. If it’s equal to the highest yield at the auction, you will probably receive the TIPS with the yield requested, but not the full par value. The key word there is “probably”. They will, if they can, clear the auction without issuing bonds at the highest offered yields. If you offer a yield above the highest acceptable yield range at the auction, you won’t receive the TIPS at all.
The minimum purchase at auction is $100, and the price of Treasury Inflation-Protected Securities rises in $100 increments. There are limits to the amount of TIPS you can buy from the auction, but the limit is hard to reach. In a noncompetitive auction the limit is 5 million in bonds, in competitive auctions it is 35% of the total amount of TIPS available.
The Treasury Inflation-Protected Securities principal itself adjusts according to inflation to the consumer price index. At maturity, which comes in terms of 5, 10, or 30 years, you will receive your final interest payment and the inflation adjusted principal value. Interest is then calculated from the adjusted par value at a fixed rate. If deflation occurs the principal may also decrease, and inflation will be calculated from the deflated value. You should note that, in actual history, deflation is relatively rare.
The actual Interest Payments occur semiannually. The taxation on the semiannual interest payments must occur in the year they are made. They are subject to federal level taxation, but exempt at state and municipal levels. If you are charged state or municipal income taxes, these bonds assist with avoiding them while providing hedges against inflation.
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