Inflation Risk

Inflation risk refers to the possibility of a reduction in the value of the income or assets. In fact, inflation risk surfaces when the inflation tends to decrease the purchasing capacity of a currency. The condition where inflation leads to reduction in the value of money irrespective of whether it is invested or not, is known as Inflation Risk. Inflation Risk may also be defined as the uncertainties involved with the actual value of an investment in future. Inflation risk destabilizes and weakens the performance of an investment.

Nature of Inflation Risk:

• The vulnerable nature of Inflation Risk reveals the sensitivity of a stock to sudden changes in the rate of inflation.
• The demands of the customers regarding luxury products decline, owing to erosion of the real income by inflation. Subsequently, the stocks of the luxury items tend to become more vulnerable to inflation, thereby increasing the scope for Inflation Risk.
• Most of the stocks are negatively exposed to Inflation Risk. This is because, a sudden increase in the rate of inflation creates a downward pressure on the prices of the stock.

Also known as the Purchasing Power Risk, Inflation Risk exerts the following effects on the economic conditions of a country:

• Inflation Risk indicates that there are more chances of the inflation to rise than the original expectation. This is precisely why the investors and other analysts hypothesize the rate of inflation substantially and scrutinize its indicators like the Yield Curve carefully, to make out the possibilities of Inflation Risk.
• Inflation Risk continues to be a common matter of concern for the income investors across the world. This is because inflation makes the currency of a country to lose its value. As a result, any investment involving flow of cash becomes vulnerable and prone to Inflation Risk.
• Owing to Inflation Risk, the investor has a low return than his/her estimated expectation. This makes the investor to withdraw some part of a portfolio principal, in case he/she is dependent on it for his/her earnings.