Pippa purchased a 15-year bond with a face value of $5,000 and a 7% coupon rate at the time of issuance. The bond is due to mature later this year…

The bond provides a fixed nominal return (7% coupon and return of $5,000 principal at maturity). Inflation erodes the purchasing power of money over time. Because inflation has risen, especially recently, the $5,000 principal that Pippa receives at maturity will buy fewer goods and services than it could have when she initially invested it 15 years ago. This loss of purchasing power on the returned capital is a primary risk for investors in long-term, fixed-income securities, known as inflation risk or purchasing power risk.

A. A rise in inflation decreases the real rate of return (Nominal Return - Inflation Rate) on a fixed-income investment, it does not increase it.

B. A capital loss occurs if a bond is sold before maturity for less than its purchase price. At maturity, the investor receives the full face value, which is a return of principal, not a capital loss.

D. The 7% is a coupon payment (interest income), not capital appreciation. Bonds do not have a fixed annual capital appreciation rate.

1. Canadian Securities Institute. (2023). Investment Funds in Canada Course Textbook. Chapter 6: Fixed-Income Securities, Section 4: Risks of Investing in Bonds, pp. 6-15 to 6-16.

2. Bodie, Z., Kane, A., & Marcus, A. J. (2021). Investments (12th ed.). McGraw-Hill Education. Chapter 10: Bond Prices and Yields, Section 10.2: Bond Pricing. (Discusses the relationship between interest rates, inflation, and bond values).

3. Fabozzi, F. J. (2016). Bond Markets, Analysis, and Strategies (9th ed.). Pearson. Chapter 3: Bond Price Volatility. (Explains inflation risk and its impact on the real return of fixed-coupon bonds).