TREASURY INFLATION PROTECTED SECURITIES:

NEW PERSPECTIVES ON THEIR SIGNIFICANCE TO PORTFOLIOS

Ron D'Vari, Ph.D., Managing Director, State Street Research & Management

Lal C. Chugh, Ph.D., Professor of Finance, University of Massachusetts, Boston

ABSTRACT

. The paper analyzes TIPS, one of the new instruments offered in capital markets. TIPS have not received adequate attention to date from academic researchers. More importantly, they have been misunderstood by some practitioners as a way of expressing views on inflation rather than real rate fluctuations. This paper takes a different approach than the classical portfolio diversification and efficient frontier approaches to justify the need for TIPS. We offer new perspectives on the risk-reward of TIPS under possible growth and inflation scenarios. The examination of price sensitivities and cash flows of TIPS, floating-coupon bonds, and nominal fixed-coupon bonds allow for arguing that TIPS are “market completing”, hence useful to investors. We further illustrate that TIPS offer additional flexibility to active fixed income portfolio managers to take diverse views on inflation and expected real growth, separately.