The price and yield quotes are perhaps the source of most confusion about buying individual TIPS on the secondary market. Unlike regular ("nominal") bonds, TIPS are quoted in real price and real yield while the actual purchase is done with nominal dollars.

Let's take a look at an actual quote from Fidelity for one specific bond. The screenshot below was taken in December 2008.

There are a bunch a numbers. What do they mean?

Coupon: 2.000. It means this bond will pay 2.000% annual interest rate. All TIPS pay interest twice a year. The interest payment is calculated as follows:

inflation adjusted principal on the interest payment date * coupon rate / 2

Therefore this bond will pay you twice a year 1% (one half of the coupon rate) of the inflation adjusted principal on the interest payment date.

Maturity Date: 01/15/2016. This is when the inflation adjusted principal will be paid back to you. If you need your money back before then, your only choice is selling the bond on the secondary market. You can also tell by the maturity date when the bond will pay interest. TIPS always pay the last interest on the maturity date. Therefore this bond will pay interest on January 15 and July 15 every year. Some other bonds will pay interest on April 15 and October 15 every year.

Rating: AAA. All Treasury bonds are rated AAA because they are guaranteed by the U.S. government.

Price Bid/Ask: 96.031/96.965. The first number is the bid price, which is the price the dealer pays you when you sell. The second number is the ask price, which is the price you pay the dealer when you buy. When you are buying, pay attention to the ask price. These numbers are expressed as a percentage of inflation adjusted principal (see Inflation Factor discussed below). The ask price of 96.965 means you pay 96.965% of the inflation adjusted principal if you buy this bond from the broker. Some brokers display the prices in a number followed by a multiple of 1/32. For example 96-31 means the whole number 96 plus a fraction of 31/32, which equals 96.96875 in decimal.

Yield Bid/Ask: 2.620/2.471. These are real (after inflation) Yield to Maturity (YTM) expressed in percentages. YTM is an internal rate of return calculation for all the cash flows from a bond. A real YTM is calculated using cash flows in real terms. The first number is the bid yield, which is the yield you give up when you sell. The second number is the ask yield, which is the yield you receive when you buy. The ask yield is usually lower than the bid yield. For this bond, if you buy at the broker's ask price of 96.965, your real YTM is 2.471%.

Inflation Factor: 1.09333. This is unique to TIPS. The principal value of TIPS is adjusted by this multiplier. It's also called the index ratio. The index ratio changes every day with inflation with a 2-month lag. Around the 17th of every month, when the Consumer Price Index (CPI) number for the previous month is announced, the Treasury department publishes the index ratio for every TIPS bond for the following month. At any point of time, you know what the index ratios will be in the next 15 - 45 days.

When you buy stocks, the unit is one share. When you buy bonds, the unit is one bond. By bond convention, one bond is $1,000 in face value. The inflation adjusted principal is $1,000 multiplied by the index ratio. Therefore the inflation adjusted principal for this bond is $1,093.33. The ever changing index ratio makes your bond keep up with inflation and deflation.

Adjusted Price Bid/Ask: 104.993573/106.014743. These are bid/ask prices multiplied by the inflation factor a.k.a. the index ratio. If you multiply the ask price of 96.965 by the index ratio of 1.09333, you get 106.014743. Because they are a simple multiplication, not all brokers display these in their quotes. Fidelity is showing these numbers here for your convenience.

There is one more piece of data that's not shown in the quote. It's called accrued interest. Accrued interest is the interest between the last interest payment date and today. If you buy the bond today, you will receive six months worth of interest on the next interest payment date. But because the current owner owned it between the last interest payment date and today, it's only fair that they receive a portion of the interest. Therefore when you buy the bond from the current owner, you have to pay them the interest they already earned. Because it's simply an advance, accrued interest is usually not included in the price quote. If you want to know the all-in cost including accrued interest, you can use my spreadsheet:

Spreadsheet: Buying TIPS on Secondary Market

So altogether, the quote is showing you that if you accept the quote and buy this bond, you will have a bond that

• matures on Jan. 15, 2016;
• pays 2% annual interest rate multiplied by the ever changing inflation adjusted principal;
• has an inflation adjusted principal of $1,093.33
• costs 96.965% of inflation adjusted principal ($1,093.33) plus accrued interest
• gives you a real Yield to Maturity of 2.471% (before broker commission)

In addition to these numbers in the quote, if you use my spreadsheet, you will also see

• the all-in cost including accrued interest is $1,069.80518 per bond;
• if you buy 10 bonds and your broker charges you $40 commission, your total cost for 10 bonds is $10,738.05;
• with the broker commission, your real YTM is now 2.413% (versus 2.471% before broker commission).