In the Schweser book 2 at page 100, paragraph before Taylor Rule, it is said “Higher inflation is a positive for cash, …” and page 108 Cash instrument paragraph it is said that Cash managers reduce the maturity when interest rates increase. In others words during high inflation period cash returns increase but as the interest rates increases cash instrument value decrease !? Isn’t is contradictory ? Thanks
In the examples you provided, “cash” referes to two different things. “Cash managers” are those who use fixed income securities rather than derivatives.
Second example is about cash instrument managed by Cash Managers
found this confusing myself. Doesn’t cash lose real purchasing power in inflationary environments? Maybe they mean money market or something?
Yeah they mean money mkt. Because MM rates increase when inflation increase. The cash mamanger is probably a manager of CDs or commercial paper.
markCFAIL Wrote: ------------------------------------------------------- > found this confusing myself. Doesn’t cash lose > real purchasing power in inflationary > environments? Maybe they mean money market or > something? this is just one example why using the cfai material solely is a good idea if you have the time to go thru it all…i agree the intuitive thing to say is that inflation is negartive for cash but no the cfa material states that higher inflation will be coupled with higher interest rate environment which is a positive for cash…not how i would think about it but it makes sense
Cash instrument means shot term debt (less than 1 year) As you said interest rate is positive for cash instrument (to fight against inflation) but as you know, higher interest rates means lower price for debt. So it is contradictory !
Instead of splitting hairs, let’s split fixed income instruments into two: 1. Money market (less than one year to maturity) 2. Bonds (more than one year to maturity) When inflation rise, central banks raise short term interest rates. Increase in rates will reduce prices of bonds. If I have cash, I would put my money in money market (cash) instruments at higher yields, which is positive. If I know rates will rise, I will reduce maturity of my investments to short term securities.
inflation increases interest rates, which affects all fixed-income investments. The lower the duration (like cash), the more the reinvestment rate effect outweights the interest rate effect.
I like your answer gjertsen although diffcult to visualize. Any simple exemple ?
well, a long term bond gets completely hammered when interest rates rise, because it’s locked into a coupon of something like 4% and comparable bonds are now paying 5%. A short term bond loses a little value on the price side (but much less than the long term bond because of the lower duration). Additionally, as it matures and is reinvested in another short term bond, it benefits ultimately from the higher interest rates, because of the reinvestment rate. Longer term instruments hedge reinvestment rate risk but are vulnerable to interest rate (price) risk should rates increase. Shorter term instruments hedge interest rate (price) risk, but are vulnerable to reinvestment rate risk should rates decrease.
I totaly agree. In conclusion, inflation is good for cash instrument, specially if we decrease the duration of the cash instrument.