What is an inflation premium?
Inflation premium is a method used in investment and banking to calculate the normal rate of return on an asset or investment when over time increases the general costs of goods and services known as inflation. The actual yield, or the actual rate of return, is therefore reduced by inflationary bonuses, and this decrease is greater, the longer the investment lasts adolescence. An example would be a government bond that brings 5% return on investment in one year, but with an inflation bonus over the same year 1% for price increases. This reduces the real bond return to 4% by the end of the year.
Inflation risk has a significant impact on the value of investment over time, especially in terms of investments with a very long horizon before maturity. Government bonds, which last 25 to 30 years, may actually result in less than the initial investment due to inflationary bonus compared to such a time that negates a small percentage of profits on the bond. Due to the effect of inflation on nominal return for anyThe investment is an important part of all financial investments over time.
Since the inflationary risk can lead to a negative return or loss of value for investment, it is important for long -term security, such as a bond that factor inflation by hesitating it to the coupon. The coupon rate is a percentage of bond yield on the basis of current interest rates. Overall, inflation increases interest rates in the economy and if the income from investment is not modified to compensate over time, it will lose value.
The yield curve for the investment, however, does not only take into account inflationary bonuses and interest rates. The same meaning is what is called risky bonuses. Premium risk is the calculation of how Lidokud will be ripening, will be the failure of the company in which it was invested, where the entire security value could be lost.
If the investment they haveRevenue linked to increasing interest rates, such as bonds, are reportedly based on what is called the nominal interest rate. The nominal interest rate is a value that has been achieved without inflation. To obtain this nominal return for the investment, three other degrading factors are added and deducted from that income for the investment. The nominal interest rate is therefore the same as the actual return on the investment when it is paid.
An example of how it is calculated can be illustrated with a link that has a yield of 8% and matures in one year. If the actual interest rate per year is 1%, the inflation bonus is 2%and the risk bonus is 3%, then the actual yield for bond or nominal interest rate will only be 2%, as all these other costs that worsen the value of the bond. In practice, however, it is often true that risk bonuses abandon these calculations if the company is considered very stable and unlikely to be in the short or long -term mountainsThe isont stopped doing business. Since risk bonuses are more theoretical than actual costs such as inflation bonuses or real interest, if they are taken into account, they often end up in the fact that the profit of investment looks less than it actually turns out when frightened.