When inflation rises, which bondholder's real returns are most negatively affected?

When inflation rises, the real returns of bondholders are impacted by how inflation affects the purchasing power of the interest payments and the principal when it matures. Among the various types of bondholders, corporate bondholders tend to be most negatively affected by rising inflation for several reasons.

Corporate bonds generally offer fixed interest payments. When inflation increases, those fixed payments lose purchasing power, meaning the real value of the money received decreases. Unlike government bondholders, corporate bonds often carry higher risk and can be affected by the creditworthiness of the issuing corporation, which may not be as stable during inflationary periods. Additionally, if inflation rises, central banks might increase interest rates to combat it, leading to lower bond prices. Corporate bondholders might find their investments particularly vulnerable as companies may struggle to maintain profitability in an inflationary environment.

Municipal bondholders may experience a different dynamic due to the tax-exempt status of many municipal bonds, which can sometimes provide a cushion against inflation. Foreign bondholders can also face unique currency risks that may offset their real return impacts differently compared to corporate bonds. Government bonds, often seen as safer investments, provide an avenue through which inflation-indexed bonds (such as TIPS in the U.S.) can help protect against rising prices.