Question

answer your question in 150 words.

Describe the relationship between bond prices and inflation.

Would you be more inclined to buy bonds if you anticipate interest rates to rise fall. Explain your thought process regarding your decision.

Answer 1

The bonds prices are affected by inflation as well as changing interest rates. Increase in inflation will cause a decline in the bond prices since Bond prices and inflation are inversely related.

The reason for this is that the relative value of the interest that is paid by a specific Bond declines as inflation increases. Investors are worried that the yield of a bond will not be able to keep up with the inflation causing a decline in the demand of that Bond. A decline in the demand causes the prices to drop.

If I anticipated interest rates to increase I would not buy bonds because the bond would pay a fixed rate of interest which would not increase along with the rising interest rates. On the contrary if I expected interest rates to decline I would buy bonds because I Would Still receive the fixed interest rate prescribed by the bond in spite of the decline in interest rates