Chapter 17.1, Problem 4R

To determine

To evaluate the relationship between fixed income and inflation

Explanation of Solution

When inflation results in higher interest rates, it can have a negative effect on fixed-income assets. Central banks, as in the United States. Usually the Federal Reserve has inflation expectations. If inflation continues to go above the target level, regulators will raise interest rates.

When interest rates from existing fixed-income securities become less competitive in contrast with newer higher-rate fixed-income instruments, prices of current fixed-income assets will usually decline. In other words, an inverse relationship exists between rate of interest and fixed-income prices of the assets. High inflation may also weaken the returns from fixed-payment strategies.

Economics Concept Introduction

Introduction: Inflation is generally characterized as a gradual rise in the level of prices for goods and services across an economy. There is no common opinion on the primary cause of inflation, although most economists believe that inflation frequently occurs within the economy during times of economic growth.