Feels like a trick question so im going to say A
Should be C… unexpected inflation above expectations will decrease the real value of cash instruments.
^ but you could say the increase in inflation will be met with raising rates
A. you can easily reinvest cash instrument at the new high yield
C. When we think of cash instruments, the return is already low. so the real value of instrument is declining due to unexpected inflation.
Yes, rising rates is bad for fixed income investments, even short, liquid investments such as cash instruments.
This would result in the answer being B, at best, since your new higher rate would only reflect an increase in inflation and not a real increase in value.
I think you’re over thinking this, my final answer is C. Lets hope someone posts the correct answer with an explaination soon so we can stop wasting time here.
^ Yeah, I wonder if this guy is just trolling us posting some open question like this. Where’s the answer??
My answer would have been C. I understand the argument for A but just b/c inflation is higher than expected doesn’t mean very short-term rates will rise on the spot. I think long-term interest rates would rise on the data b/c of expected higher rates in the future but I think rates will be pretty stable on the short-term until the Fed adjusts them through open market operations. Until that happens, higher inflation is bad for cash investments. I easily could be wrong, though. I’ve learned through the program I’m wrong quite often!
^ unexpected increases in inflation will change the expectations of fed action. This change in expectations actually changes the short term rates, Fed action just confirms it.
Also important to keep in mind cash makets are typically discount instruments held to maturity. market value does not matter if its held to maturity but the reinvestment rates do matter.
Correct Answer is A. Inflation above expected rate will result in central bank increasing rates to tame inflation, which is good for cash.
Spurious at best, is this another finquiz question?
I am often finding they make huge assumptions in their answers that are a reach from the question being asked.
^ I don’t think its a good question. I basically agree with what everyone on here said on both sides but I’m no expert.
I only post this b/c I think the CFAI does a very good job with the questions they put on the exam. Through my limited experience, these types of questions that are open to interpretation aren’t asked on the first Saturday in June. I may get pissed at the topics covered (I was bombared by an entire item set on the Level II exam last year), but the question writing quality is excellent.
but for the naysayers talking about finquiz - pretty sure this is a table in the text …
check out exhibit 18 in the book please. … (2014 edition) pretty sure there would be a similar table in your 2015 reading.
Inflation/Deflation Effects on Asset Classes (Institute 59)
You and the others are right. It’s clear as day on page 59 of the 2015 “Economic Analysis and Asset Allocation” book. Thanks for pointing it out. Specifically it says inflation above expectations have a “bias toward rising rates”. These presumed rising interest rates would have to be enough to offset (and more) the higher inflation in terms of real return to have a positive effect, but whatever.
On page 59, deflation has a negative effect on cash instruments, too. The CFAI also defines deflation on the prior page as “an increase in the purchasing power of a unit of currency” so that doesn’t sound negative to me, but I don’t think the focus is on purchasing power on that chart – it’s on the direction of interest rates, apparently.
It’s a little convoluted and the text even mentions exceptions, but I will take what the CFAI chart says and move on!
Thanks to all for bringing it up b/c I would have lost points on this on exam day.