Inflation

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Inflation

  1. 1. <ul><li>Inflation is the increase in prices over time </li></ul><ul><li>Correspondingly, it represents the fall in the value of money over time </li></ul><ul><li>The purchasing power of money gets reduced due to inflation </li></ul>What is inflation? FINWIZE INVESTMENTS
  2. 2. <ul><li>Inflation would affect different entities to a different extent </li></ul><ul><li>The affect would depend on the extent of price increase in their class of commonly used goods </li></ul><ul><li>Price change would not be in the same proportion for all goods in a class </li></ul><ul><li>“ Basket of goods” concept </li></ul>How is inflation determined ? FINWIZE INVESTMENTS
  3. 3. FINWIZE INVESTMENTS The value of Rs. 1,00,000 will become Inflation (% p.a.) No. of Yrs. 2 3 4 5 6 0 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 5 90,392 85,873 81,537 77,378 73,390 10 81,707 73,742 66,483 59,874 53,862 15 73,857 63,325 54,209 46,329 39,529 20 66,761 54,379 44,200 35,849 29,011 25 60,346 46,697 36,040 27,739 21,291 30 54,548 40,101 29,386 21,464 15,626
  4. 4. FINWIZE INVESTMENTS
  5. 5. <ul><li>List five different goods/commodities utilised by </li></ul><ul><ul><li>A construction firm </li></ul></ul><ul><ul><li>An urban household </li></ul></ul><ul><li>Wholesale Price Index (WPI) </li></ul><ul><li>Consumer Price Index (CPI) </li></ul>Inflation indexes FINWIZE INVESTMENTS
  6. 6. <ul><li>Index of wholesale prices </li></ul><ul><li>Basket of goods include </li></ul><ul><ul><li>wholesale grains </li></ul></ul><ul><ul><li>power </li></ul></ul><ul><ul><li>cement </li></ul></ul><ul><ul><li>steel amongst others </li></ul></ul><ul><li>Most commonly referred index </li></ul>Wholesale Price Index (WPI) FINWIZE INVESTMENTS
  7. 7. <ul><li>Index of retail prices </li></ul><ul><li>Basket of goods include </li></ul><ul><ul><li>grains (retail price) </li></ul></ul><ul><ul><li>toothpaste </li></ul></ul><ul><ul><li>soap amongst others </li></ul></ul><ul><li>Captures the increase in the ‘cost of living’ </li></ul>Consumer Price Index (CPI) FINWIZE INVESTMENTS
  8. 8. Cost of Living
  9. 9. <ul><li>The inflation (CPI) for the next year is expected to be 4%. A cake of lifebuoy is for INR 10 today. How many cakes can you buy after 1 year with INR10? </li></ul><ul><li>Price of one cake =10*(1+4/100)=10.4 </li></ul><ul><li>No. of cakes = 10/10.4=0.962 </li></ul><ul><ul><li>Inflation has reduced the Purchasing power </li></ul></ul>Exercise FINWIZE INVESTMENTS
  10. 10. <ul><li>Simply put, it is the price of money </li></ul><ul><li>It is the compensation for the opportunity cost of lending the money </li></ul>Interest FINWIZE INVESTMENTS
  11. 11. <ul><li>A rate of return is expected to at least account for inflation </li></ul><ul><li>Money would grow only when returns above inflation are available </li></ul><ul><li>Consequently, inflation also has a bearing on the interest rates </li></ul>Rate of return FINWIZE INVESTMENTS
  12. 12. <ul><li>Nominal rate of return is the absolute return offered (e.g. Infrastructure bond @9.32%) </li></ul><ul><li>All investment instruments are quoted in terms of nominal rate </li></ul><ul><li>Real rate are return which have been adjusted to take inflation into account </li></ul><ul><li>Real rate=Nominal rate-inflation </li></ul>Rate of return FINWIZE INVESTMENTS
  13. 13. <ul><li>Salaries at ABC Inc have grown by 4% this year. The relevant inflation index is 4.3%. What is the real rate of increase? </li></ul><ul><li>Real=Nominal - Inflation=4-4.3=-0.3% </li></ul>Rate of return FINWIZE INVESTMENTS
  14. 14. <ul><li>Inflation robs away purchasing power </li></ul><ul><li>@5% inflation, INR 105 one year hence would be equal to INR 100 today </li></ul><ul><li>Hence, the timing of income/payment streams assumes importance </li></ul><ul><li>Present Value(PV)= Future cash flow/ appropriate discount </li></ul><ul><li>It tells us the worth of FCF today </li></ul>Time Value of money FINWIZE INVESTMENTS

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