Chartered Financial Analyst (CFA) Practice Exam Level 2

What are the main factors affecting Breakeven Inflation Rate for corporate bonds?

1. Credit spread and corporate profitability

2. Real expected inflation and uncertainty about actual inflation

3. Market volatility and dividend yield

4. Stock risk premium and real estate valuation

The correct answer is: Real expected inflation and uncertainty about actual inflation

The Breakeven Inflation Rate (BEIR) for corporate bonds reflects the market's expectations of future inflation, factoring in the risk of the bond issuer. The primary components that influence BEIR are real expected inflation and the uncertainty surrounding actual inflation outcomes. When investors consider purchasing corporate bonds, they assess the expected real return, which is adjusted for inflation. As real expected inflation rises, investors demand higher yields on bonds to compensate for the diminished purchasing power. Additionally, uncertainty regarding whether inflation will meet expectations adds a layer of risk that investors must consider. If there is significant uncertainty, bond yields may increase as investors seek additional compensation for the risk of unexpected inflation outcomes. Thus, the combination of expected inflation rates and the uncertainty regarding those rates directly shapes the breakeven point at which the nominal bond yield equals the real yield adjusted for anticipated inflation. Other factors listed, such as credit spread and corporate profitability, while relevant in the context of bond pricing, do not specifically address the mechanics of breakeven rates tied to inflation expectations.