Inflation risk, also known as purchasing power risk, is the possibility that inflation would reduce the real value of an investment’s cash flows.
What is inflation risk also known as?
Inflationary risk, also known as inflation risk or purchasing power risk, is a term used to characterize the long-term danger that inflation poses to a portfolio. It specifically refers to the chance that inflation-affected price increases would surpass the profits on your investments.
What are the four different kinds of inflation?
When the cost of goods and services rises, this is referred to as inflation. Inflation is divided into four categories based on its speed. “Creeping,” “walking,” “galloping,” and “hyperinflation” are some of the terms used. Asset inflation and wage inflation are two different types of inflation. Demand-pull (also known as “price inflation”) and cost-push inflation are two additional types of inflation, according to some analysts, yet they are also sources of inflation. The increase of the money supply is also a factor.
What are the three different types of inflation?
- Inflation is defined as the rate at which a currency’s value falls and, as a result, the overall level of prices for goods and services rises.
- Demand-Pull inflation, Cost-Push inflation, and Built-In inflation are three forms of inflation that are occasionally used to classify it.
- The Consumer Price Index (CPI) and the Wholesale Price Index (WPI) are the two most widely used inflation indices (WPI).
- Depending on one’s perspective and rate of change, inflation can be perceived favourably or negatively.
- Those possessing tangible assets, such as real estate or stockpiled goods, may benefit from inflation because it increases the value of their holdings.
Is the risk of inflation systematic?
Stock price volatility is one way academic researchers use to assess investment risk. Stocks are subject to two types of risk: systematic risk and unsystematic risk. Systematic risk, often known as market risk, cannot be mitigated by stock market diversification. Inflation, interest rates, conflict, recessions, currency changes, market crashes and downturns, as well as recessions, are all sources of systematic risk. Systematic risk is always there in the stock market since it is unpredictable.
Changes in macroeconomics are largely to blame for systemic risk. Using asset classes whose returns are not highly correlated can help minimize portfolio risk by reducing systematic risk (e.g., quality bonds, stocks, fixed-rate annuities, etc.). Through a process known as portfolio optimization, it is feasible to get higher risk-adjusted returns without taking on additional risk.
Unsystematic risk, also known as company-specific risk, specific risk, diversifiable risk, idiosyncratic risk, and residual risk, refers to the risks associated with a single company, such as management, sales, market share, product recalls, labor disputes, and brand awareness. This is a risk that is unique to an asset and can be mitigated by diversification.
The standard deviation, or variation of the mean (not annualized) return of a portfolio’s returns, is used to calculate the portfolio’s risk (systematic + unsystematic). Table xx shows how rapidly unsystematic risk is decreased in a single-stock portfolio when a small number of stocks are added. The table is based on an article published in the Journal of Business in October 1977 by E.J. Elton and M. J. Gruber. When a portfolio has 20 or more stocks from several industries, the majority of unsystematic risk is reduced.
To put it another way, holding 200+ equities (or a single, broad-based US stock index fund) can eliminate 61 percent of stock risk; owning only 20 stocks from various sectors can reduce risk by 56 percent. A well-diversified stock portfolio’s total risk is essentially the same as systematic risk. While an investor expects to be paid for taking on risk, such as unsystematic risk, he or she does not expect to be rewarded for taking on unneeded risk.
Diversification and the Reduction of Dispersion, a classic 1968 study by Evans and Archer, determined that an investor holding 15 randomly chosen stocks would have a portfolio no more risky than the whole stock market. This research backs up Benjamin Graham’s guidance in The Intelligent Investor, published in 1949. For optimal diversification, Graham advocated owning 10-30 stocks.
What is referred to as political risk?
Political risk refers to the possibility that an investment’s returns will suffer as a result of a country’s political upheaval or instability. A change in government, legislative bodies, other foreign officials, or military power could all cause instability that affects investment returns. Political risk, often known as “geopolitical risk,” becomes more of a consideration as the investment horizon lengthens. They’re categorized as a form of jurisdiction risk.
What are the two different types of inflation?
Keynesian economics is defined by its emphasis on aggregate demand as the primary driver of economic development, despite the fact that its modern interpretation is still evolving. As a result, followers of this tradition advocate for government intervention through fiscal and monetary policy to achieve desired economic objectives, such as increased employment or reduced business cycle instability. Inflation, according to the Keynesian school, is caused by economic factors such as rising production costs or increased aggregate demand. They distinguish between two types of inflation: cost-push inflation and demand-pull inflation, in particular.
What is inflation, and what produces it?
Other factors could drive aggregate demand and, as a result, price levels higher. Population growth, for example, boosts aggregate demand. Higher export profits provide exporting countries more purchasing power. Having more purchasing power means having more aggregate demand. If the government repays its public debt, purchasing power and, as a result, aggregate demand may rise.
The holders of illegal money have a tendency to spend more on conspicuous consumption goods. This type of behavior feeds the inflationary fire. As a result, a number of things contribute to DPI.
(iii) Cost-Push Inflation Theory:
Aggregate supply, in addition to aggregate demand, contributes to the inflationary process. We term inflation CPI because it is caused by a leftward change in aggregate supply. CPI is frequently linked to non-monetary issues. CPI is a measure of inflation caused by rising production costs. A rise in the cost of raw materials or an increase in labor could raise the cost of production.
Wage increases, on the other hand, may contribute to a rise in worker productivity. If this happens, the AS curve will shift to the right, rather than the left. Despite an increase in pay, we assume that productivity does not change.
Firms pass on such cost increases to consumers by raising the prices of their products. Costs rise in tandem with earnings. Price increases are a result of growing costs. Moreover, rising costs drive trade unions to seek higher pay once more. As a result, an inflationary wage-price spiral develops. As a result, the aggregate supply curve shifts to the left.
This may be seen graphically in Figure 1, where AS1 represents the initial aggregate supply curve. This AS curve is positive sloping below full employment, and it becomes absolutely inelastic at full employment.
The price level is determined by the intersection point (E1) of the AD1 and AS1 curves (OP1). The aggregate supply curve has shifted leftward to AS2. With no change in aggregate demand, this raises the price level to OP2 and lowers output to OY2. With a decrease in output, the economy’s employment declines or unemployment rises. A higher price level (OP3) and a lower volume of aggregate output come from a further shift in the AS curve to AS3 (OY3). As a result, CPI can occur even before a person reaches full employment (YF).
(iv) Causes of Cost-Push Inflation:
The cost variables are what cause the prices to rise. The growth in the price of raw materials is one of the major drivers of price increases. For example, the government can raise the price of gasoline or diesel or the freight rate by issuing an administrative order. Firms are now paying a greater premium for these inputs. As a result, the cost of production is under increased pressure.
Furthermore, CPI is frequently acquired from outside the economy. OPEC’s increase in the price of gasoline forces the government to raise the price of gasoline and diesel. Every industry, especially the transportation sector, need these two vital raw commodities. As a result, transportation costs rise, resulting in an increase in the overall price level.
Wage-push inflation or profit-push inflation can both cause CPI to rise. As a compensation for rising inflationary prices, trade unions demand increased monetary pay. If rising money wages outstrip rising labor productivity, aggregate supply will shift upward and to the left. Firms frequently use their power to increase profit margins by raising prices regardless of consumer demand.
Changes in fiscal policy, such as higher tax rates, put upward pressure on production costs. An increase in the excise tax on mass consumption goods, for example, is unquestionably inflationary. As a result, the government is accused of inducing inflation.
Finally, manufacturing difficulties may lead to output reductions. Natural disasters, slow depletion of natural resources, labor stoppages, power outages, and other factors could reduce aggregate output. In the middle of this output decline, merchants and hoarders create artificial scarcity of any items, which simply exacerbates the issue.
Other factors include inefficiency, corruption, and economic mismanagement. As a result, a variety of factors interact to generate inflation. Any increase in inflationary prices cannot be blamed on a single factor.
What causes inflation and what causes inflation?
Inflation is caused by increases in government spending, hoarding, tax cuts, and price increases in international markets. Prices rise as a result of these variables. Inflation is also caused by rising demand, which leads to higher prices.