RAS question
Inflation-indexed bonds protect investors against:
Correct answer: (D) Erosion of real returns due to inflation.
Inflation-indexed bonds protect investors against the erosion of real returns caused by inflation.
Explanation
Inflation-indexed bonds are designed to preserve an investor's real return when prices rise. The RBI describes Inflation Indexed Bonds, for retail and wholesale investors, as bonds that provide protection from erosion of real returns due to inflation, with inflation measured through indices such as CPI and WPI. The investor is not being protected against every financial risk, but against inflation eating into the purchasing power of the return. These instruments adjust returns for inflation, with principal and interest linked to CPI or WPI, and India's 2013 WPI-linked issue followed later by CPI-linked instruments.
Why the other options are wrong
- (A) Stock market crashes affect equity prices, while inflation-indexed bonds are bond instruments built around inflation adjustment, not equity-market protection.
- (B) Currency depreciation is an exchange-rate risk, whereas the stated purpose of inflation-indexed bonds is protection against inflation-linked erosion of real returns.
- (C) Default risk concerns failure to repay, but these are framed as government bond instruments and the tested protection is inflation indexation, not default insurance.
Concept
This tests the Indian Economy concept of government securities and inflation protection. It recurs in RAS because candidates must distinguish inflation risk from market, currency and default risks in standard financial instruments.