See: TIPS.
You buy a muni bond that's yielding 3%, net. Meaning no taxes from the Feds or the State. But it's of long duration. This issue, coming from Park City, Utah for other Utahians, isn't payable for 20 years. That is, it'll pay 3% interest for 20 years, twice a year, and then pay back the principal 20 years from now.
But you're worried that inflation will make the $25,000 you want to invest "feel like" it's only worth $10,000 by the time they pay it back. So they offer an inflation adjustment feature, wherein a number is agreed upon before the issue as being the authority on inflation, i.e., what the actual number was. Usually, that's a Federal number, and it might not directly correlate to what's going on in Park City...but at least it's a start, and hopefully close.
So that indenture might proffer that the eventual principal payout will fluxuate with inflation, such that its notional amount is $25,000, but it may go up...and it may go down, should we have decades of deflation. But that eventual principal return, in this type of bond, will be some adjusted number, so that in today's dollars, it's returning $25,000 at the end. No more, no less...at least, as driven by inflation.
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Finance: What are T-Notes, T-Bonds and T...18 Views
Finance allah shmoop what are t notes t bills and
tips All right we'll see that tea in there Well
it stands for treasury and all of these air one
flavor or another of government debt that is the u
s government raises cash for itself teo fix roads build
bridges and erect statues of lebron james dunking on the
statue of liberty or you know whatever else he thinks
the public wants or needs it does that by auctioning
off these debt securities with the promise of its full
faith and credit to pay back the money is the
paper specifies well t notes are quote mid range unquote
paper in that they generally have maturity ease of two
three five seven and ten years that's a teen note
t notes carry a stated interest rate and look a
lot like a normal corporate bond paying interest twice a
year T bills on the other hand are generally very
short term paper usually coming due within a few days
all the way up to a year they're sold or
auctioned at a discount meaning that the t bill might
promise to pay a thousand bucks if it comes due
In six weeks you might pay nine hundred ninety six
dollars for it and you get a whopping fee Four
bucks an interest for your six weeks hard work of
owning that t bill and just you know sitting there
kind of looks like a zero coupon bond Okay so
now we have tips that's tips treasury inflation protected securities
tips as in show us your tips getting Why do
we have such a thing Well the problem with super
duper safe bonds like those of the u s government
is that investors holding them a long time often do
worse after taxes than inflation meaning that if inflation is
growing at three percent a year in their bonds are
only returning one percent a year after tax while then
the investors actually losing two percent a year in buying
power and that's a problem in nineteen nineties when investors
started to realize this issue well they began Tio you
know stop buying u s government bonds and that's a
huge problem for a country that desperately needs to borrow
cash all the time So rather than risk a liquid
marketplace where there's just no buyers buying government paper uncle
Sam created tips which basically adjust the end value of
the principle that investors get based on the c p
i or consumer price index which is a measure of
the average selling prices of a carton of milk a
gallon of fuel a dozen eggs and a grand slam
breakfast at denny's Basically what happens is that the price
of the principal the investor gets back goes up with
inflation over time So they're not losing buying power and
that's a big deal That's it go Enjoy your grand 00:02:33.995 --> [endTime] slam It'll be fourteen thousand dollars in fifty years