Inflation erodes the purchasing power of a bond 's future cash flows. A rise in inflation will cause investors to demand higher yields to compensate for inflation rate risk. Also, prices will tend to drop because the bond will be paying interest with less purchasing power.
The idea of “risk” is used in many fields and industries. There has been large efforts made towards the understanding of risk. Since, risk varies so much depending on the field of study, the need for learning about it is warranted. As can be imagined, the importance of risk in a market economy is crucial. In the 1990s, JP Morgan made the Value at Risk (VaR) a central component of its work efforts (Cecilia-Nicoleta, Anne-Marie, & Carmen-Maria, 2011).
Such decisions may affect the company’s profitability today but judging from the fact that high risk means low stock price and vice-versa, high return waits in the future.
In today’s economy, the American public has raised the question of the value of the American dollar and how the changes are going to affect this world. The value of the dollar is considered to be less than it was many years ago. Our economy has been threatened by inflation and it does affect the value of the dollar. The dollar has lost more than half of its value and it doesn’t buy as much as it used to. However according to Nguyen” the dollar is gaining momentum. The dollar gained for a second day after a report showed U.S. durable goods orders exceeded forecasts in July, bolstering the outlook for economic growth” (Nguyen 2015).
Inflation can diminish the buying power of a dollar. When the yearly inflation rate surpasses the 'rate of return ', the market participants lose invested funds due to the deterioration of purchasing power. According to several financial articles, the significance of inflation on investment is subjective to the kind of securities held. A higher yield on a stock is not a safer expenditure; one most also take into consideration the risks involved. Interest rate risk can affect various bonds in different ways. A bond 's yield-to-maturity is the "discount rate" used to make the present value (PV) of all the bond 's cash flows equal to its price. When a bond 's yield rises, its price goes down, when a bond 's return decreases, its price goes up. For example, according to the article titled "How Interest Rate Changes Affect the Price of Bonds" it states, "the discount rate applied is the percentage of interest prevailing in the market for bonds of the similar risk and maturity."
Inflation is the rate of increase in prices for goods and services. A rise in inflation decreases the purchasing power of money, meaning consumers would have to pay more for a product than they would have had to a year earlier. It is widely accepted that there are two types of inflation, demand-pull inflation and cost-push inflation. Demand-pull inflation is triggered by demand surpassing the economy’s ability to produce those goods and services required to satisfy demand. Cost-push inflation occurs when prices increase due to a rise in production costs. This leads to a fall in aggregate supply meaning a rise in the price of goods and services. (Boundless).The government believes it is vital to have low inflation and the target has been 2% for many years. Inflation influences other key economic policies such as employment, the interest rate and exchange rate. (BBC business). Inflation is measure by the Office for National Statistics, there are two methods of measuring Inflation, consumer price index (CPI) and retail price Index (RPI), the primary objective of each method is to calculate the changes in the price of products in a basket. Both have over 700 items assigned to their basket, what differentiates both is that the RPI basket also includes housing costs such council tax, mortgage interest payments as well as state benefits and pensions (The Telegraph). The basket is updated annually, items are brought in or taken out depending on consumer spending patterns, this is to
Disadvantages of inflation include high inflation rates that can cause hesitation and mistakes leading to less investment. It is discussed that countries with higher inflation, have lower rates of investment and economic growth. The higher the inflation the lower world-wide competitiveness. Another disadvantage is menu costs and the costs of changing price lists, stabile wage growth and declining incomes. Most importantly it can dcreas the real value of savings, which may affect older people who live on savings. However, it does depend on whether interest rates are higher than the inflation rate.
Inflation is defined as a sustained increase in the general level of prices for goods and services . It is measured as an annual percentage increase. When there is an inflation, the same amount of money buys a smaller percentage of a good or service compared to previous years. This means the value of money drops when inflation occurs. In economics, the value of money is viewed in terms of purchasing power, which is the real, tangible goods that can be bought by money. When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 3%, then theoretically a 1£ bottle of water will cost 1.03£ in the following year. After inflation, the same amount of money could not buy the same amount of goods it could beforehand.
Several literatures reveal a good number of different approaches and theories to the price of risk. The two main competing economic theories we shall consider are the classical expected utility theory, and the dual theory of risk which was developed by Yaari(1987).
Inflation is general defined as the devaluation of the currency with the comprehensive and continued rising price level, which means the purchase of money is persistent declining (James and Charles 1975). And this is generally considered as the result of the amount of money in circulation more than the actual needs of the economy. It will directly leads to the devaluation of paper money. If the income of residents do not change, then the living standard of citizens will dropped, which might result in the social and economic disorder and can negatively impact the development of the economy. However, within a certain period of time, moderate inflation can stimulate consumption, expand domestic demand and promote economic development (Trevithick and Mulvey 1996). For example, sometimes the government borrow money from the central bank to expand financial investment and take measures to ensure that the private sector investment is not reduced, which promote economic growth as a result of the increase in total investment. Another case is for producers that the speed of product prize rising is always faster than the that of the nominal wage, so the profit of the enterprise in the short term will increase, and the enterprise will expand investment, as a result, have an positive effect on the economy.
Inflation is the rate in which the prices and services are rising above zero percent, which involves a declining value in the power of currency. While deflation is when the inflation rate goes below zero, making it a negative inflation rate. “Inflation has a direct impact on the investment environment; a rising or declining inflation rate can shift the balance of investment returns between stock, bonds, and other alternatives” (Little, 2010). An economy having zero inflation will eventually result in deflation, which can be defined as a fall in the general price level. Economists tend to track and estimate the general price level using several different price indexes. One of the best-known price indexes to measure inflation is the consumer price index (CPI). In most developing countries, what considered being a healthy growth rate for the economy is have an annual interest rate of CPI around 2%. Inflation is used as a tool to maintain the level of general goods and services. Having remarkably high inflation can interfere with the operation of the financial market, and making the purchasing power of currency decreases. Also, it makes it more complicated for people to make good consumer decisions. Thus, making countries tend to target their inflation rate around CPI 2%, keeping the inflation rate low as possible, as it will keep the interest rate positive.
Inflation is defined as the sustained increase in the general price levels of goods and services over a period of time. When the price level rises, each unit of a currency purchases fewer goods and services, reflecting a reduction in purchasing power per unit of currency. Every economy experiences inflation through the business cycle, which is defined as the natural fluctuation in economic activity between inflation (expansion), and recession (contraction). Inflation is not necessarily a negative factor for an economy because it reflects an expansionary trend of the business cycle that could translate into growth if managed accurately through controlled and efficient monetary policy.
Many people consider the return on their investments in nominal terms, or the stated return on an investment. In phases of low inflation, if you believe a government bond fund to yield 2%, considering this as a 2% return is not especially detrimental. However, when inflation increases, thinking in these nominal terms can be very harmful, particularly to long-term investment planning.
Inflation is an aspect of macroeconomic instability and is a rise in the general level of prices in an economy. When inflation occurs, every dollar of income buys fewer goods and services than before and reduces the purchasing power of money. Inflation doesn’t always mean all prices are rising, and during periods of rapid inflation some prices may be constant and others may fall. It is measured by the Consumer Price Index (CPI), the two types are demand-pull and cost-push, and affects the nominal and real interest rates, unanticipated and anticipated inflation, nominal and real interest rates, and hyperinflation.
Inflation is generally, defined as sustained or continuous increase in the general price level in an economy. Inflation has been described and categorised in terms of the rate at which the general price level is increasing , market mechanism , expectations and causes. In explaining the causes of inflation one common cause always surfaces for consideration and that is that inflation occurs when aggregate demand is growing at unsustainable rate leading to increased pressure on scarce resources. Or Inflation can be caused when aggregate demand exceeds aggregate supply. This is commonly referred to “demand-pull” factors. Other factors mentioned in economic theory are the “cost push” factors, inflation expectations.