What are inflation-protected securities and how do they help with inflation risk?

• A. Fixed principal and coupon regardless of inflation
• B. Provide tax-exempt income
• C. Shield against deflation by increasing principal under deflation
• D. Inflation-protected securities adjust principal value with inflation, helping preserve purchasing power

Answer: (D)

Inflation-protected securities are designed to guard against rising prices by adjusting the investment’s value with inflation. For these securities, the principal is increased when inflation rises (measured by a price index like the CPI). Because interest is paid on the inflation-adjusted principal, both the periodic payments and the amount you receive at maturity grow with inflation, helping to preserve purchasing power. They’re not fixed-principal investments, and they don’t provide tax-exempt income. They aren’t meant to shield against deflation; the principal can move with deflation as well, though at maturity you typically receive at least the original principal. In short, their key feature is adjusting the principal for inflation to maintain real value.