A financial analyst predicted that the inflation rate would go up from 1.5% in 2018 to 6% in 2020. He advised investors not to buy bonds because their prices would fall as inflation increased.

• Explain why bond prices fall when inflation increases.
• Analyze the relationship between the price of bonds and interest rates.
• Appraise how interest rates are determined using the following models and whether the different models produce different results in determination of interest rates:
  • Demand and Supply
  • Bond Market
  • Money Market
• Evaluate how each of the following affects interest rates and the price of bonds:
  • Yield to Maturity
  • Bond Yields
  • Risk

Answer rating: 100% (QA)

ANSWER 1 Bond prices fall when inflation increases because inflation erodes the purchasing power of future cash flows Bonds typically have fixed coupon payments which are a percentage of the bonds fac... View the full answer