Who is most directly exposed to inflation risk (the risk that rising prices reduce the real purchasing power of fixed dollar payments)?

• A. A retiree receiving a fixed nominal pension payment each month
• B. A worker whose wages are automatically indexed to the Consumer Price Index (CPI)
• C. A borrower with a fixed-rate student loan who experiences higher-than-expected inflation
• D. A homeowner with a 30-year fixed-rate mortgage who unexpectedly experiences higher inflation

Answer: (A)

Verified step by step guidance

1. Step 1: Understand what inflation risk means. Inflation risk refers to the possibility that rising prices will erode the real value or purchasing power of fixed nominal payments over time.
2. Step 2: Identify which parties receive fixed nominal payments. A retiree receiving a fixed nominal pension payment each month gets a set amount of money that does not adjust with inflation.
3. Step 3: Consider how inflation affects each option. For example, a worker whose wages are indexed to the CPI will have wages adjusted upward with inflation, protecting their real income.
4. Step 4: Analyze the impact of inflation on borrowers and homeowners with fixed-rate loans. Higher inflation reduces the real value of fixed-rate debt payments, which can actually benefit borrowers by lowering the real cost of their debt.
5. Step 5: Conclude that the retiree with fixed nominal payments is most directly exposed to inflation risk because their income does not increase with rising prices, reducing their real purchasing power.