NISM Certifications · NISM-Series-V-A: Mutual Fund Distributors · Investment Landscape
Which of the following best describes inflation risk for an investor holding a bank fixed deposit?
Inflation risk is the risk that the purchasing power of an investment's returns declines because prices rise faster than the interest earned. A fixed deposit paying less than inflation gives a negative real return, even though the principal is nominally safe.
- AThe risk that the bank may fail to repay the principal
- BThe risk that the purchasing power of the returns falls because prices rise faster than the interest earnedCorrect
- CThe risk that the deposit cannot be encashed before maturity
- DThe risk that interest rates rise after the deposit is made and a better rate is missed
Explanation
Inflation risk is the erosion of real purchasing power when the rate of price rise exceeds the return earned. Failure to repay is credit risk, inability to encash is liquidity risk, and missing higher rates is reinvestment or opportunity risk.
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