Inflation risk, also called purchasing power risk, is the chance that the cash flows from an investment won't be worth as much in the future because of changes in purchasing power due to inflation.
HOW IT WORKS (EXAMPLE):
For example, $1,000,000 in bonds with a 10% coupon might generate enough interest payments for a retiree to live on, but with an annual 3% inflation rate, every $1,000 produced by the portfolio will only be worth $970 next year and about $940 the year after that. The rising inflation means that the interest payments have less and less purchasing power. And the principal, when it is repaid after several years, will buy substantially less than it did when the investor first purchased the bonds.