Why do bond prices drop when inflation increases?
Bond prices drop whenever the value of bonds is perceived by the bond market to have diminished. Increasing inflation is one factor that can make bonds that have a fixed interest rate, such as U.S. Savings Bonds and Treasury Bills, less attractive to investors.Face ValueA bond is worth its face value plus accumulated interest. When the bond matures, the bondholder will be paid the face value plus all accumulated interest. The date of maturity is stated on the bond.Future ValueThe value of a given sum of money to be paid in the future is less than the same sum of money in the present. This is why interest is paid on all debt obligations, including bonds.InflationIn an inflationary economy, the purchasing value of money goes down as prices go up. This lessens the future value of money, as lent money that is repaid will have less purchasing power than before. Therefore, interest rates will have to be higher to compensate the lender for that loss of future value.EffectSince most bonds carr
