As an investor, you must look at your real rate of return. Unfortunately, investors often look only at the nominal return and forget about their purchasing power altogether. This article briefly discusses the importance of inflation risk and the various instruments that are available in the market for hedging inflation risk."Let the Treasury promise to pay not $1,000 but a sum that will have the same purchasing power as $1,000 had when the security was issued. Let it pay as interest each year not a fixed number of dollars but that number adjusted for any rise in prices."

Over the year economists and politicians mainly worried about deflation. The prospect of US and European economies following Japan into a period of falling prices has prompted investors to switch from equities to bonds. Now deflationary pressure has been erased and in most of the developed countries the threat of inflation is rising again. As per the latest report (March 2003), America's core rate of consumer-price inflation (excluding energy and food) unexpectedly jumped to 1.6%, from a low of 1.1% in January.

Japan's economy has also rebounded its deflationary pressures and in the euro area, inflation is starting to edge up again. In China, which was facing deflation little more than a year ago, inflation has risen to 3% and many economists expect it to exceed 5% before the end of the year. Keeping inflation low but positive is good for economy; resurgence of inflation is definitely a risk.

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