In the context of Bonds, consider the following statements:

1. Bond Prices fall when inflation increases

2. Bonds help in Capital Preservation.

Which of the statements given above is/are correct?

Solution

● Statement 1 is correct: The twin factors that affect a bond's price are inflation and changing interest rates. A rise in either interest rates or the inflation rate will tend to cause bond prices to drop. Inflation and interest rates behave similarly to bond yields, moving in the opposite direction from bond prices. In short, inflation makes interest rates go up. This in turn makes bond values go down. Exception- A Bond with a fixed coupon rate will hold the same interest rate, no matter what happens in the market. ● Statement 2 is correct: Unlike stocks, the principal value of a bond is returned to the investor in full at maturity. This can make bonds attractive to risk-averse investors who are concerned about losing their capital. Although bonds are often viewed as a capital preservation tool, they also offer opportunities for capital appreciation.