INFLATION PROTECTED BONDS
Be Sure to Include the Following in Your Analysis:
1. How do regular (nominal) Treasury bonds work? How does inflation impact the coupons and principal of a regular T-Bond? How are TIPS different from regular Treasury bonds? When do TIPS outperform/underperform regular Treasuries?
2. What effect do you think an increase in real interest rates has on the price of TIPS? And an increase in realized inflation? An increase in expected inflation? An increase in inflation risk? Are these effects different for a regular Treasury bond? 3. TIPS and risk management: How can we combine regular (nominal) Treasuries and TIPS to build a hedge portfolio that has exposure to inflation risk but not to real interest risk? 4. What is Harvard’s Policy Portfolio? How is this portfolio determined? 5. How does HMC develop its capital market assumptions? Why does HMC focus on real returns when making its forward-looking view of expected returns and risk? What do HMC’s capital market assumptions imply for the US equity premium and the foreign equity premium?
6. Should TIPS be considered an additional asset class in Harvard’s Policy Portfolio? 7. What are HMC’s assumptions about the expected real return on TIPS, its volatility, and its correlation with the real return on the other asset classes? What is the correlation of TIPS with the proposed Policy Portfolio excluding TIPS? What do they imply about real interest rates and inflation risk?
8. What do HMC’s capital assumptions imply about the optimal allocation to TIPS and other asset classes in a mean-variance framework? Should Harvard invest its endowment in TIPS?
9. Do TIPS have advantages or disadvantages beyond their mean-variance properties that make them an attractive asset class for investors with long investment horizons such as Harvard?