1.We have seen that bond prices can be affected by changes in interest rates. Bond prices can also be affected by changes in inflation, which is the percentage changes in the overall price level of an economy. For example, if inflation is 2% per year, then it means that goods and services are becoming 2% more expensive over the year, on average.

a.Bond prices tend to decline with high inflation. Can you offer a reason for why this might happen? (HINT: Does a bond's coupon payment change over time or stay fixed?)

b.If bond prices tend to decline with higher inflation, how would bond yields react to higher inflation? What does this suggest about a relationship between interest rates in the economy and the inflation level of an economy?