Tuesday, April 28, 2009

the impact of unexpected inflation on the price of a common stock

A company is financial statements can be used to obtain a rough estimate of the impact of a divergence between actual and expected inflation on the value of the firm is common stock. Each item can be classified as either a real, short-term monetary, or long- term monetary asset or liability. in some cases the classification is fairly obvious; in others it is some-what arbitrary. However, detailed Knowledge of a company and\or sumer price index in recent years, but there is probably more to it than this.
One cannot help be struck with the fact that those who invested in short-term securities over this period frequently ended up with less purchasing power than they started with: real return was negative in 23 of the 53 years. perhaps even more surprising, the average real return over the period was zero!
while expected real returns may vary from year to year, the variation may be relatively small. if so, investors may well have been willing to invest in short-term highly liquid securities even though they expected to earn nothing at all in real terms. if they are willing to do so still, such securities will be priced to give an expected real return of approximately zero.
if this assumption is made, the "market’s" predicted rate of inflation over the near future can be estimated by simply looking at the current annual yield on short-term government securities. In a sense, Treasury bill yields represent a consensus prediction of inflation-a prediction likely to be more accurate in many cases than the predictions of any single forecaster.

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