Chapter 3 Valuing Bonds 61
bre44380_ch03_046-075.indd 61 09/30/15 12:47 PM
Prices can fall as well as rise. The U.S. experienced severe deflation in the Great Depres-
sion, when prices fell by 24% in three years. In Japan, which has experienced persistent defla-
tion, prices in 2014 were lower than they had been 20 years earlier.
The average U.S. inflation rate from 1900 to 2014 was 3.0%. As you can see from
Figure 3.6, among major economies the U.S. has been almost top of the class in holding infla-
tion in check. Countries torn by war have generally experienced much higher inflation. For
example, in Italy and Japan, inflation since 1900 has averaged over 10% a year.
Economists and financial managers refer to current, or nominal, dollars versus con-
stant, or real, dollars. For example, the nominal cash flow from your one-year bond is
$1,100. But if prices rise over the year by 6%, then each dollar will buy you 6% less next
year than it does today. So at the end of the year $1,100 has the same purchasing power as
1,100/1.06 = $1,037.74 today. The nominal payoff on the bond is $1,100, but the real payoff
is only $1,037.74.
◗ FIGURE 3.5
Annual rates of inflation in the
United States from 1900–2014.
Source: E. Dimson, P. R. Marsh, and
M. Staunton, Triumph of the Optimists: 101
Years of Investment Returns (Princeton, NJ:
Princeton University Press, 2002), with updates
provided by the authors.210
215190019101920193019401950196019701980199020002010250510152025Annual inflation, %◗ FIGURE 3.6 Average rates of inflation in 19 countries from 1900–2014.
Source: E. Dimson, P. R. Marsh, and M. Staunton, Triumph of the Optimists:
101 Years of Investment Returns (Princeton, NJ: Princeton University Press, 2002), with updates provided by the authors.024681012Average inflation, %SwitzerlandNetherlandsU.S.
CanadaSweden Norway
New ZealandAustraliaDenmarkU.K.
Ireland Average
South AfricaGermany
(ex 1922/23)SpainBelgiumFranceFinlandJapanItaly