This is from an answer key: T-bills are government issued securities and are therefore considered to be default risk free. More precisely, they are nominal risk-free rates rather than real risk-free rates since they contain a premium for expected inflation. ------------------------------------------------- How do t-bills have an inflation premium. I thought only TIPS compensate for inflation? If T-bills have an inflation premium, don’t all bonds have an inflation premium? Can someone name a security without an inflation premium?
You are confused I think: only TIPS have no inflation premium, all other securities would have an inflation premium.
wow, I am confused. I thought TIPS would have inflation premium because your yield changes with inflation, that is, if inflation rises your yield rises to match that. That sounds like an inflation premium? I don’t understand.
no, a premium is something an investor demands to compensate himself for taking on some form of additional risk. If there is a risk that the value of an asset will decline due to inflation, you would demand an inflation premium as compensation (eg you would want a higher rate of payment)
perfect. thanks.
Bump It’s a pretty simple thread, but it’s a fundamental point. That and I hate economics (deeply).
Also don’t forget that TIPS adjust the principal value, not the interest payment. The payment changes because the inflation is tacked on to the principal.