Question

1. Elaborate on how inflation influences bond prices. What is a profitable strategy, if you think inflation will drop from its present levels?.

please answer in essay form

Answer 1

If the levels of inflation will rise, interest rates will rise, the yields will rise as investors will demand a higher yield as compensation for the higher inflation and the risks. The bond prices will fall. If the inflation level will fall, the yield will fall and the bond prices will rise.

In case, we are holding a bond at current levels of inflation and we expect that the inflation will drop from the current levels , then the prices of the bonds will rise . The bond will now trade at a premium. The investors can enjoy bonds which are now priced higher than what they had purchased earlier. The bond holders can now sell these bonds at a price higher than what they originally paid for.