Hi, I have trouble to understand the effect of inflation on interest payment. It is usually said that high inflation reduces the value of interest payments. Can you please explain how? The same when I studied the Multinational operations reading. When a company is operating in an inflationnary environment, a net asset position (A>L) on the BS will result in a loss and a net liability position (L>A) will result in a gain. Could you please explain how? Thanks in advance,
Interest payment is fixed at 6% of $1,000. Inflation is 12% a year. Therefore that interest received no longer has the purchasing power it used to have.
Loubna51 Wrote: ------------------------------------------------------- > Hi, > > I have trouble to understand the effect of > inflation on interest payment. It is usually said > that high inflation reduces the value of interest > payments. Can you please explain how? “… reduces the value of interest payments.”, not the amount of interest payments. Good for the one paying, not good for the one receiving. > The same when I studied the Multinational > operations reading. When a company is operating in > an inflationnary environment, a net asset position > (A>L) on the BS will result in a loss and a net > liability position (L>A) will result in a gain. > Could you please explain how? If you have assets they get hurt by the rising inflation. Just like an individual…if you have cash or deposits at some fixed rate, high inflation eats away at your assets, while if you have a loan and you are making payments, the bank suffers the loss. Another way of looking at it is that in almost all cases, high inflation leads to higher interest rates, but your assets keep yielding the low rates…whie your payments are relatively small, since you are paying at lower rate.