Test your knowledge

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If you earn interest on an inflation-adjusted bond, _______.

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The income is tax-deferred

The income is taxed as ordinary income by the IRS

You only have to pay tax on coupon interest, not principal interest

The income is taxed as ordinary income by the IRS. If you earn interest on an inflation-adjusted bond, the income is taxed as ordinary income by the IRS.

Par value measures the effects of inflation.

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True

False

False. The CPI-U measures the effects of inflation.

A bond's principal will lose its purchasing power over time unless it is adjusted for inflation.

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True

False

True. That is why some bonds adjust their interest rates to stay ahead of inflation.

The principal of an inflation-adjusted bond is always guaranteed to its investor.

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True

False

False. The principal of an inflation-adjusted bond is guaranteed by the full faith and credit of the US government if an investor holds onto it until its maturity.

The process of selling a bond's coupons and principal separately is called stripping.

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True

False

True. Stripping involves separating the two from each other.

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