An inflation rate included in a bond’s interest rates is one which is an inflation rate________?
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Answer: B. Expected in future
Explanation
The inflation rate incorporated into a bond's yield is based on expected future inflation over the instrument's life. Investors demand higher nominal interest rates to compensate for the anticipated purchasing power erosion caused by future inflation. Bond pricing models factor in inflationary expectations to determine appropriate nominal yields required by market participants. The Fisher effect explains mathematically how nominal interest rates comprise real interest rates plus expected inflation rates. Central bank monetary policies heavily influence inflation expectations and long-term bond yields across global financial markets. Investors use inflation-linked bonds to protect their portfolios against unexpected surges in future price level increases.
At bond issuance reflects historical price levels rather than the forward-looking expectations priced into bond interest rates. Expected at time of maturity is too narrow because inflation impacts purchasing power across the entire holding period. Expected at deferred call ignores ongoing inflationary impacts occurring throughout the active life of the bond.
- Subject
- Accounting and Finance
- Category
- Finance
- Topic
- —
- Difficulty
- medium
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