Inflation and asset returns (On Page 91, Book 2 of Schweser) economic, interest, returns, between, please

Daniel1985

about inflation and bond price;
Schweser says;
Inflation is negative for bonds.
I know the relationship with bond price and INTEREST RATE.
but what with INFLATION??
economic expansion–interest rate rise–bond price drops
economic expansion–high inflation–bond price drops??
is there any direct relationship between inflation and interest rate?
please explain the mechanism..

hassan

Hi,
A high inflation leads to higher interest rates, which in turn reduces bond prices. Further high inflation ‘cannibalizes’ your fixed income return in a sense that your real return is reduced as your nominal return is somehow fixed (unless you have inflation-protected-securities).
Regards
STS

lucasg85

economic expansion–high inflation–interest rate rise–bond price drops.
May be this way you understand.
Why inflation is high (in general) : Economy expanding (may be due to govt stimulus, less taxes, more disposable income in the hands of general public). Everyone has money then. Too much money chasing the available goods. Prices go up. Inflation Goes up.
If someone, at that point, asks you to defer your current purchase of say HomeTheatre System which costs today @ $1000. Seeing all prices going up, you also think the HT will cost next year say $1100 which is 10% more. Now if anyone tells you to defer your purchase and gives you 5% (next year you will get 1050) you will say NO. You will atleast ask for 10% based on the present view you have on inflation. Say after 10days you expect inflation woulb be 20% by next year. Now you will atleast expect 20% as compensation to defer your purchase and lend money.
Am I right ? If there is any disconnect please clarify.

kseniaru

Most important point to remember is that interest rates take into account anticipated inflation. If I currently earn a nominal rate of 3% when inflation is 2% I earn a real rate of 1%. If inflation is expected to increase to 10% and I still want to earn a real rate of 1%, nominal interest rates must increase to 11%. This increase in inflation expectations increased interest rates and subsequently decreased bond prices. Make sense?