Question: Indicate how an unanticipated 5 percent jump in the inflation rate will influence the wealth of the following:.
When prices rise, people worry whether the rise in their income will keep pace with inflation, and the more quickly prices rise, the more people suffer from the stresses of inflation and its uncertainties. People will constantly feel they have been fooled and cheated. Expectations about inflation affect future cash flow and require return and cost of capital followed directly from the present value equation. (Emery, Finnerty, 1997).
A. A person whose major asset is a house with a 30-year mortgage at a fixed interest rate.
As the text stated, inflation is an increase in the general (average) price level of goods and services in the economy. It indicates that it is very outstandingly good opportunity for the person. He or she would be very happy if inflation unanticipated jump up 5 percent. Like inflation, the purchasing power of a house will be reduced. For example, the 100,000-dollar loan that the person borrowed for a house, the loan could not buy the same house at the same amount next year. It would be a 105,000-dollars loan. In the same way, the interest rate will be increased sooner or later in long run. Then, the amount of money for purchasing the house will be increased while he or she just pays the same amount at fixed rate over 30 years by now. .
In addition, he or she does not worry about going up of interest rate because the interest rate will be increased sooner or later. If a rapid increase in price threatens to cause a consumer-spending boom and higher consumer-price inflation, a central bank will raise interest rates. (Economist,2002).
B. A family holding most of its wealth in long term fixed yield bonds.
The family that receives yield or payment from long term bond would be unsatisfied because the same amount of money is having less valuation of purchasing. This inflation indicates this situation would be negative for a family.
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