Future Business Leaders of America (FBLA) Securities and Investments Practice Test

What is a significant risk for fixed-income investors during inflation?

1. Increased interest payments

2. Loss of purchasing power

3. Reduced portfolio diversification

4. Higher tax liabilities

The correct answer is: Loss of purchasing power

The significant risk for fixed-income investors during inflation is the loss of purchasing power. When inflation rises, the value of money decreases over time, meaning that the fixed interest payments received from bonds or other fixed-income investments will not stretch as far in terms of purchasing goods and services. Essentially, the returns on these investments may not keep pace with rising prices, leading to a decrease in the real value of income generated from these securities. For instance, if a bond pays a fixed interest rate, and inflation significantly increases, the actual value of those interest payments becomes less effective at providing the same level of financial security or lifestyle for the investor. This diminishes the remaining capital as it diminishes the investor's ability to purchase the same amount of goods and services they could afford prior to inflation. In this context, the other options present relevant factors but do not capture the core issue of inflation's impact on fixed-income investments in the same way. Increased interest payments may occur if interest rates rise, but they don’t specifically address the core risk posed by inflation concerning fixed payments. Reduced portfolio diversification relates more to the investment strategy rather than the macroeconomic influence of inflation. Higher tax liabilities can affect investors, but this situation is more about tax policy than the direct effects