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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

Which feature of the 1970s inflation environment was most damaging to long-term fixed-interest financial products such as conventional bonds and level annuities?

High, unexpected inflation eroded the purchasing power of fixed nominal payments, so real returns on conventional bonds and level annuities became negative when inflation exceeded their yield. This hurt holders and stimulated demand for inflation-linked and equity-based products.

  1. AReal returns turned negative when inflation exceeded the nominal yieldCorrect
  2. BNominal yields were fixed by law at zero
  3. CInflation reduced the nominal value of coupon payments
  4. DFalling oil prices increased real coupon values
  5. Deflation raised the real value of liabilities

Explanation

Fixed nominal coupons lose purchasing power when inflation is high, so real returns can become negative if inflation exceeds the yield. Coupons do not fall in nominal terms, ruling out C. Deflation was not the 1970s problem, so E is wrong.

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