Impact on Asset Classes
Cash Deposits
- Need to distinguish between nominal and real interest rate. Nominal interest is the amount
being paid and real interest is after taking inflation into account. - E.g. an account pays 1.5% but inflation is running at 0.3%, thus real interest rate is 1.2%
Fixed Interest Securities
- Investors receive same income if prices rise or fall. Purchasing power of income will change.
- Inflation over the term of the security will result in real value of capital repayment falling.
Equities
- Equities are usually seen as a hedge against inflation because good companies will increase
profits in line with inflation. - This means that they can pay out higher dividends.
Questions - Use Your Note Taker To Jot Down Ideas / Calculations
Francis has a portfolio which includes UK shares, cash and fixed interest securities. Over the next two
years, inflation is predicted to rise. It is TRUE to say this would typically:
a) be supportive for his fixed interest holdings.
b) be supportive for his equity holdings.
c) be negative for his equity holdings.
d) have no impact on his cash holdings.
B)
Inflation will be negative for fixed interest and cash holdings as it will erode real value. Inflation is
generally seen as supportive for equity holdings.
- Further Study Text: Pages 120-121