Inflation is good for cash?

CFA Level III
#1

Reading 17 LOS g. From schweser “Higher inflation is a positive for cash because the returns on cash instruments increase as inflation increases”…since when? basic economics says inflation hurts cash since it erodes the value of money. i get that “cash” here is t-bills but risk free rates dont necessarily increase with inflation increases

any opinon?

#2

Inflation certainly erodes your purchasing power . Thus is surely negetive for cash balance. Inflation hurts cash.

#3

I think this is one of those differences between the real world and the CFAI curriculum.

I’m just going to leave this quoted here. Gonna write the bolded on the exam if it comes up.

#4

agreed, your purchasing power is hurt by inflation. However, perhaps it has something to do with the expectation of higher nominal interest rates in the future. As a result, you would sell longer dated bonds and invest in shorter dated (low duration) bills. You then roll your short term cash position at higher rates every 3 or 6 months for example

#5

Okay I have read the passage from Schweser. Basically it’s just arguing cash instruments the yield is increasing. All else equal in order for you to match the same real return during higher inflation is for nominal return/yield of cash instruments to increase. That’s why bond prices fall, since new bonds have a higher yield compare to old bonds (with inflations). This have nothing to do with actual cash

#6

CFAI curriculum says that “inflation above expectations” is positive for cash instruments as there’s a “bias toward rising rates” hmm…

#7

Raising interest rates to stem inflation will increase the return on cash investments and savings

#8

sdanalyst alread answered it in a nutshell. Basically, inflation hurts cash IF the company keeps the cash under a big mattress.

Cash, for analysts, is mostly very short term securities. You’re reinvesting them all the time, and enjoying the higher yields brought in by inflation.

You don’t get more value in real terms, but while your nominal assets are growing, your fixed debt is getting smaller in real terms. You keep your purchasing power, but your creditors don’t. That’s a good thing.

To answer the OP, RF rates tend to increase when inflation increases (on the long run, for most markets in the world, etc). When that link doesn’t happen, real RF rates may get negative, which is very much an exception, since people would pay to save and get paid to borrow in real terms.