Definition
Inflation risk is particularly damaging to fixed-income investments because coupon payments are typically fixed in nominal terms. High unexpected inflation reduces the real return. TIPS and inflation-linked bonds protect against this risk. Shorter-duration bonds are less affected because they can be reinvested at higher nominal rates more quickly.
functions Formula
Real Return ≈ Nominal Return − Inflation Rate
lightbulb Example
A bond yields 4.5% nominally, but inflation is 5%. Real return ≈ -0.5%. The investor loses purchasing power despite earning a positive nominal yield.
verified_user Key Points
- Fixed coupons lose purchasing power during high inflation
- TIPS provide direct inflation protection
- Shorter-duration bonds can adapt faster
- Unexpected inflation is the true risk (expected inflation is priced in)