Question

Explain the impact of inflation on rates of return.

Briefly discuss the 5 different interest rate levels required by investors in recent periods

Answer 1

Question 1)

Impact of inflation on rates of return:

A rational investor invests his money to earn high rates of return at a minimal risk level. The basi idea is to compensate for the opportunity cost of not investing the funds elsewhere or spending the same on good and services currently.

Inflation refers to the rise in price levels of goods and services in an Economy due to various factors, most evidently, the devaluation of currency. It basically means 'too much money chasing too few goods'.

Rate of return refers to the minimum return expected by investors from their invested funds.

Rising inflation can erode an investor's annual rate of return because when he invests it, he actually loses money due to a decline in purchasing power. Inflation renders the investor's funds less valuable and hence in such times, it would be prudent for him to spend on goods and services currently rather than having the money worth less in the future.

When Financial entities expect a rise in inflation, they offer a higher interest rate on securities to attract investors. Thus, investors must make a prudent decision as to when they should invest and when they should spend the money at their disposal.