The difference in yield between TIPS and non-indexed Treasury bonds reflects:

Question

BlackTom AI · Accepted Answer

TIPS pay a real yield while conventional Treasuries pay a nominal yield, so the spread between them measures expected inflation.

1. Relevant knowledge points and concepts
- TIPS (Treasury Inflation-Protected Securities) adjust principal with inflation (CPI) and therefore deliver a real interest rate (return above inflation). 
- Non‑indexed (nominal) Treasuries pay a fixed nominal interest rate that compensates investors for both the real return and expected inflation (Fisher relation).
- Fisher equation (approximate): nominal rate ≈ real rate + expected inflation. Therefore, nominal − real ≈ expected inflation.

2. Complete reasoning process step by step
- Let r_real be the TIPS yield (real yield) and r_nom be the nominal Treasury yield.
- According to the Fisher relation: r_nom = r_real + π_e (where π_e is expected inflation, ignoring small product term).
- Rearranging: π_e ≈ r_nom − r_real. That difference is exactly the observed spread between non‑indexed Treasury yields and TIPS yields.

3. Calculations / intermediate steps (simple numeric example)
- If a 10‑year TIPS yields 1.0% (real) and a 10‑year nominal Treasury yields 4.0%, then expected inflation ≈ 4.0% − 1.0% = 3.0%.
- This demonstrates how the spread translates into an expected inflation rate.

4. Why the correct answer is correct
- Because TIPS remove inflation risk by indexing principal/coupons, their yield reflects the real component only. The nominal Treasury yield includes that same real component plus compensation for expected inflation. Thus their difference isolates expected inflation.

5. Why the other options are incorrect
- a. Nominal exchange rate: unrelated to domestic nominal vs. real bond yields. 
- b. Nominal interest rate: that is the non‑indexed Treasury yield itself, not the difference between yields.
- c. Real interest rate: that is the TIPS yield, not the spread between the two yields.

6. Conclusion
- The spread between TIPS and non‑indexed Treasuries reflects the expected inflation rate; therefore the correct answer is d.

The difference in yield between TIPS and non-indexed Treasury bonds reflects:Single choice

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