Certified Apartment Portfolio Supervisor (CAPS) Practice Exam - Module 2

How does inflation impact fixed interest rates?

1. It reduces the demand for loans

2. It typically increases fixed interest rates

3. It is significant enough to offset expected purchasing power loss

4. It has no effect on fixed interest rates

The correct answer is: It is significant enough to offset expected purchasing power loss

Inflation affects fixed interest rates in complex ways, primarily relating to expectations about future purchasing power. When inflation rises, the value of money decreases over time, which can lead lenders to seek compensation in the form of higher interest rates to offset the impact of inflation on the future value of repayments. Therefore, when inflation expectations are high, lenders often increase fixed interest rates to ensure they receive a return that maintains their purchasing power. Option C reflects the understanding that while inflation can erode the purchasing power of fixed payments, lenders adjust interest rates to compensate for this potential loss. By anticipating inflation, they can set rates that preserve the real value of the money lent, thereby ensuring that they are still making a profitable return in nominal terms, despite the inflationary pressures. It is important to note that while other choices relate to aspects of inflation and interest rates, none encapsulate the fundamental relationship between inflation expectations and fixed rates as accurately as this option does.