Inflation & Risk

8/8/2019 Inflation & Risk

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GOOD

AFTERNOONFRIENDS



INFLATION&

RISK



INFLATION

Inflation is too much money & deposit currency that is too

much currency in relation to the physical volume of

business being done.

- Kemmerer

Inflation is simply a persistent & appreciable rise ingeneral price level.

- Shapiro



TYPES

Basis of the degree of government control

Basis of political conditions

Basis of rate of inflation

Basis of scope

According to process



BASIS OF THE DEGREE OF GOVERNMENT CONTROL

OPEN INFLATIONSUPPRESSED

INFLATION







BASIS OF POLITICAL CONDITIONS

WAR TIMEINFLATION

POST WARINFLATION

PEACE TIMEINFLATION



WAR TIME INFLATION

In order to meet war expenses government increases the

supply of money. Large proportion of production is

bought by government itself. Relatively small

proportion of production is available to the people. As

result prices begin to shoot up. Thus inflation that

takes place during the course of war is called war timeinflation.





PEACE TIME

INFLATION

Underdeveloped countries need large resources for

economic planning & development programmes. Inorder to mobilize resources, government has to resort

to deficit financing. It leads to rise in prices which is

popularly known as peace time inflation.



BASIS OF RATE OF INFLATION

CREEPINGINFLATION

WALKINGINFLATION

RUNNINGINFLATION

HYPERINFLATION



CREEPING INFLATION

It refers to that inflation wherein prices rise very slowly. It

is not only beneficial to economy but is alsoconsidered essential. Some economists are of the view

that 3% rise in prices can be called creeping inflation.



WALKING INFLATION

When price rise becomes intense & quantum of inflation

gains momentum or when prices rise between 30 &40% is called walking inflation.



RUNNING/GALLOPING

INFLATION

When there is rapid increase in prices in very short period

is called running inflation. In this case, inflation rate isbetween 80 & 100% over a decade. Such an inflation

has an adverse impact on middle or poor classes.



HYPER INFLATION

It refers to a situation when prices rise at an unexpected

rate. There is an escalation of price rise. It is calledHydra-headed Monster of inflation. It puts the entire

economy out of gear.



BASIS OF SCOPE

SECTORAL

INFLATION

COMPREHENSIVE

INFLATION



SECTORAL/SPORADIC

INFLATION

When inflation affects only a particular part of the country

or covers only one or two goods like pulses, petrol etc.it is called sporadic inflation.



COMPREHENSIVE

INFLATION

When inflation is not confined to a given part of the

country or a few goods, but engulfs the entire economyand all goods, then it is called comprehensive inflation.



ACCORDING TO PROCESS

WAGE INDUCEDINFLATION

PROFIT INDUCEDINFLATION

DEFICIT INDUCEDINFLATION

STAGFLATION



WAGE INDUCED

INFLATION

Powerful labour organizations have strong bargaining

power vis-à-vis employers. They succeed in gettingtheir wages increased. This results in to higher cost of

production & increased prices. Such a rise in prices is

called wage induced inflation.



PROFIT INDUCED

INFLATION

In developed countries big companies while fixing the

price of their commodities add a given percentage of profit to the costs. This act is called mark-up. These

companies keep the mark-up quite high. Consequently

commodities prices rise very high & inflation takes

place. Such an inflation is called mark-up or profitinduced inflation.



DEFICIT INDUCED

INFLATION

Such an inflation is the outcome of deficit financing by

the government. It takes place due to increase inmoney supply in the wake of deficit financing, without

any corresponding increase in the supply of goods &

services.



STAGFLATION

It involves inflationary rise in prices & wages at the same

time that people are unable to find jobs & firms areunable to find customers for what their plants can

produce.



THEORIES OF

INFLATION

Demand pull inflation theory

Cost pull inflation theory



CAUSES OF INFLATION

Inflation is an outcome of an imbalance in demand for &

supply of goods. when demand exceeds supply or costrises then inflation takes place. Thus causes of

inflation have 2 sides:

1. Demand side

2. Supply side





CAUSES RELATED TO

SUPPLY Less production

Artificial scarcity

Taxation policy of the government

Shortage of food grains

Industrial disputes Technical changes

Lack of raw materials

Natural calamities



EFFECTS OF

INFLATION

Effect on debtors & creditors

Effect on investors Effect on fixed salaried class

Effect on agriculturists

Effect on savings

Effect on balance of payments

Effect on employment

Effect on taxes

Effect on public debts



RISK

THE MEANING OF RISK IS THE POSSIBILITY OF LOSS

OR INJURY. RISK OF HOLDING SECURITIES ISGENERALLY ASSOCIATED WITH THE POSSIBILITIES

THAT REALIZED THE RETURNS WILL BE LESS THAN

THE RETURNS THAT WERE EXPECTED.

Risk = (Probability of risk occurring) X (Impact of risk

occurring)



RISK Vs

UNCERTAINITYUncertainty

The lack of

complete

certainty, that is,the existence of

more than one

possibilities.

Risk

A state of

uncertainty

where some of the possibilities

involved a loss,

catastrophe, or



TYPES OF RISK

SYSTEMATIC RISK UNSYSTEMATIC RISK

MARKET

RISK

INTEREST

RATE

RISK

INFLATIONARY

RISK

BUSINESS

RISK

FINANCIAL

RISK

INTERNAL

BUSINESS

RISK

EXTERNAL

BUSINESS

RISK

RISK



SYSTEMATIC RISK

The systematic risk affects the entire market. Itmeans the entire market moves in the samedirection either upward or downward.

The economic conditions, political situation andthe sociological changes affects the securitymarket.

These are beyond the control of the corporateand investor.

Such as South East Asian Crisis has affected the

stock market world wide.



MARKET RISK

Market risk is defined as the portion of total variability

of return caused by the alternating forces of bull andbear markets.

When the security index moves upward is known asBull market. Bear market is just opposite to bull market.

The forces affects the stock market are of two types:

Tangible: earthquake, war political uncertainty

Intangible : market psychology



INTEREST RATE RISK

Interest rate risk is the variation in the single period

rates of return caused by the fluctuations in the marketinterest rate.

Interest rate is affects by the price of bonds,

debentures and stocks.

This change occurs due to the change in the monetarypolicy of the government. Such as change in the

interest rate of treasury bills and government bonds.

If the stock market is weak than investor will shift to

bond market to get secure rate of return.

Cost of borrowing is affected by the rate of return.



PURCHASING POWER

RISK

Variation in the return caused by the loss of

purchasing power of the currency creates this risk.Inflation is its cause.

The inflation may be demand-pull or cost-push

inflation.

Demand pull inflation ± demand for goods and

services > the supply

Cost push inflation ± when the price of the products

rises because of the increase in the cost of the raw

material etc..



UNSYSTEMETIC RISK

Unsystematic risk is unique and peculiar to a firm or an

industry. This risk stems from managerial inefficiency,technological change, availability of raw material and

labour problem.

For example : Changes in the consumer preference

affects the consumer products like TV, washing

machine, refrigerators, etc. more than they affects the

iron and steel industry.



BUSINESS RISK

Business risk rises from the inability of a firm to maintain

its competitive edge and the growth or stability of theearnings. Operating environment risks reflected on the

operating income and the earnings.

Types of business risk

Internal risk

External risk



INTERNAL RISK

Internal risk is associated with the operationalefficiency of the firm. The efficiency reflected

on the company¶s achievement of its pre-setgoals and the fulfillment of the promises to theinvestors.

Fluctuations in the sale

Research and development

Personnel management

Fixed cost

Single product



EXTERNAL RISK

External risk is the result of operating conditions

imposed on the firm by circumstances beyond itscontrol.

Social and regulatory factors

Political risk Business cycle

For example, the Indian sugar and fertilizer industry

depend much on external factors.



FINANCIAL RISK

Financial risk in a company is associated with the

capital structure of the company. Capital structure of the company consists of equity funds and borrowed

funds.

The use of the debt with the owned funds will increasethe returns to the shareholders.

Debt financing enables the firm to have funds at a low

cost.





RISK & INFLATION IN

BANKING SECTOR

Inflation might affect economic growth through the banking

sector is by reducing the overall amount of credit that isavailable to businesses. Higher inflation can decrease the

real rate of return on assets. Lower real rates of return

discourage saving but encourage borrowing. At this point,

new borrowers entering the market are likely to be of lesser quality and are more likely to default on their loans.

Banks may react to the combined effects of lower real

returns on their loans and the influx of riskier borrowers by

rationing credit.



INFLATION ON BANK

LENDING

Several economists have found that countries with high

inflation rates have inefficiently small banking sectorsand equity markets. This effect suggests that inflation

reduces bank lending to the private sector, which is

consistent with the view that a sufficiently high rate of

inflation induces banks to ration credit.

n a on on



n a on on

Asset Returns and

BankProfitability

Inflation is negatively associated with real money

market rates, real treasury bill rates, and realtime-deposit rates, that is, as inflation

increases, the real rate of return on these

instruments falls. Inflation does appear to have

a negative impact on bank profitabilitymeasures. The impact of inflation on real rates

is most evident at the extreme.



EFFECT OF RISK &

INFLATION ON INVESTORSVariation in return are caused by the loss of purchasing

power of currency. inflation risk is the probable loss inthe purchasing power of return to be reduced. In

demand pull inflation the demand of goods & servicesare in excess of their supply.

In cost pull inflation price rises due to increase in cost.The increase in the cost of raw material, labour makes

the cost of production high.

Both type of inflation reduce the purchasing power of return got by the investor that create risk.



PROTECTION AGAINST

INFLATIONARY RISK

The general opinion is that with fixed returnsecurities problem cannot solve.

Another way to avoid the risk is to have investmentin short term securities & to avoid long terminvestment.

Investment diversification can also solve thisproblem to certain extent.

By purchasing different combination of financialderivatives we can reduce the inflationary risk.



THANK

YOU

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