Analyzing Inflation's Impact on Debtors and Bondholders

The question asks to evaluate the effect of inflation on debtors and bondholders based on two statements.

Statement I: Inflation is advantageous to debtors.

• Debtors borrow money and are obligated to repay a fixed amount later.
• Inflation erodes the purchasing power of money over time.
• If the inflation rate is higher than the interest rate on the debt, the real value of the amount the debtor has to repay decreases.
• This makes it easier for the debtor to repay the loan in terms of real purchasing power.
• Therefore, Statement I is correct.

Statement II: Inflation is advantageous to the bond-holders.

• Bondholders lend money and typically receive fixed interest payments and the principal amount back at maturity.
• Inflation reduces the purchasing power of these fixed future payments.
• If inflation is high, the real return earned by the bondholder (the fixed interest received minus the inflation rate) diminishes, or can even become negative.
• This leads to a loss in the real value of their investment.
• Therefore, Statement II is incorrect.

Conclusion

Based on the analysis, only Statement I is correct. Inflation benefits debtors as the real value of their debt decreases, while it generally harms bondholders due to the erosion of purchasing power of their fixed returns.

Thus, the correct option is the one stating that only Statement I is correct.