pg230 SS6 in schweser book 2 - they talk about high inflation is positive for cash instruments as returns increase with inflation. I might be going crazy but I thought it would be the other way around? (I am thinking t-bills etc as cash instruments) any help would be greatly appreciated.
I was confused by this too. My guess is they are such short term instruments that you can reinvest at higher rates almost immediately (especially if you are talking about money market stuff). Also it could be they just don’t get hurt as bad as other securities.
If you roll your T bills every 3 months, you likely will get rates covering some of the inflation (Treasury wouldn’t be able to sell them at lower rates). What was the 3 month T-bill rate in 1980, probably not 2%? Whereas if you bought a 10 year bond and locked in a rate with embedded inflation expectation being low, you wouldn’t be compensation for the subsequent spike in inflation.
mwvt9 Wrote: ------------------------------------------------------- > I was confused by this too. > > My guess is they are such short term instruments > that you can reinvest at higher rates almost > immediately (especially if you are talking about > money market stuff). > > Also it could be they just don’t get hurt as bad > as other securities. This is also what I think. Hey mwvt, could address my DDM vs FCFE and T-Bill posts later when you get a chance. They’re just simple questions, but it’ll bug me if I don’t get a coherent answer.
olivier is right on - cash will ride interest rates (which include inflation expectations) higher.
just found this on the web on pg 3 it talks about "In the long term, short term interest rates will often increase to relfect higher inflation, and in this sense, cash instruments will often provide inflation protection. In the short to medium term, however, cash rates can lead or lag inflation significantly. This is partly as a result of their role in the management of monetary policy” http://www.staff.city.ac.uk/p.booth/Cashnotes.pdf
olivier–believe prime was 18% in 1981. cash was the best place to be…until you bought treasuries and rode the curve down.