If you do an Internet search on this topic, you can find a plethora of news, for example:
Understanding a bit about macroeconomics is crucial for investors and finance professionals. When Yellen does begin raising rates, how do you think this will effect security valuation? Specifically, what will happen to the price of bonds? What do you think might happen to stocks? What about real estate and other assets?
Will higher interest rates encourage businesses to make investments? Or will higher rates discourage investment and perhaps increase unemployment?
If you were an investment professional, what advice would you provide to your clients in a rising rate environment?
I think two main things are going to happen to the securities market when Janet Yellen raises interest rates:
ReplyDelete1.As we learned in class stocks are valued equal to the discounted flow of expected cash flows one expects to get. As interest rates rise, corporations will be more heavily burdened with debt: spending more of their cash to pay interest. This will translate into lower dividends and smaller increase in the price of the stock for the future to come. Also many firms will find investments that are currently profitable no longer profitable under higher interest rates.
2. Right now many indexes such as the S&P 500 are at very high P/E ratios (http://finance.yahoo.com/news/must-know-shiller-p-e-130033217.html). This is due to many factors, however the one I want to focus on is a lack of alternative investments. Right now treasury bonds, and corporate bonds are at historic lows. This makes them very unappealing. However, when interest rates rise there will be a shift of capital from stocks to the bond market. This shift of capital will further cause the stock market to decline.
I would recommend anyone I advised to keep a larger then usual amount of money in cash so that they can capitalize on a "correction" in the stock market when interest rates rise.
Rising interest rates will also have an adverse effect on the real estate market. The value of a house is equal to the discounted cash flows of both the down payment and the mortgage. When interest rates rise, mortgages will go up and become less affordable. For example a $500,000 house with a down payment of $100,000 at 4% interest leads to monthly payments of $1,900 for 30 years. When interest rates go up to 6% the payment increases to $2,400. It is a good time to buy a house and lock in low interest rates before they increase.
If Yellen raises the interest rates the prices of bonds will decrease. This is because the new bonds with the higher rates provide a higher return to the bond owner. This causes the demand for the bonds with the lower interest rates to decrease because of their lower return. In order to be able to sell the bonds with the lower interest rates and provide the same return as the bonds with the higher interest rates the bonds have to be sold at a discount. Stocks do not have as clear of an answer. Stock prices may go down because it is more expensive to borrow money to invest and grow, and with lower expected profits the companies stock prices will go down. On the other hand, stock prices may go up because rising interest rates is a to investors that the economy is doing well, and with these expectations of higher profits stock prices may go up. With rising interest rates the value of real estate will decrease. This is because higher interest rates make it more expensive to buy real estate. If it costs more for the owner to own the property and the owner makes less profit, then the value of the real estate is lower than it would be with lower interest rates and more profit.
ReplyDeleteThe interest rate is the price of borrowing money so when the interest rates rise the price of borrowing money rises. Rising interest rates will discourage companies from investing because it costs them more to invest.
If I were an investment professional I would advise my clients to invest in stocks. Even though there is no clear answer to what will happen to the prices of stocks, the economy is doing better so companies may still want to invest, and historically, during times of rising interest rates stock prices have increased.
BUS 241-Hybrid Spring 2015
ReplyDeleteAnthony DellaRatta
I haven't taken any economics classes in over a year, but from what I remember from the classes, along with basic common sense, & those articles I think that the biggest impact on raising interest rates will have on the economy is that the price of real estate will decrease because it will cost people more money to borrow money. Raising interest rates is a sign that the economy is doing well but it could go either way. People might prefer to start saving money if the banks' interest rates are providing a return worth keeping it there. But at the same time if people are earning more interest on their money in the bank they might be more willing to spend extra money.
The price of Bonds will decrease because newer bonds that yield a higher return rate will be more favorable than the bonds with the lower return rate.
My advice would be to invest. the more money being spent & invested will cause business to grow and the economy will grow along with it. If money is just being left in the bank and no one is borrowing and investing the economy will continue to stand still
In a rising rate economy there are many factors that can sway individuals in varying directions. The one that I would like to focus on, at this moment in time, is the affect on the real estate market, focusing on the buyers market as well as the contracting market. Business investment depends on the interest rate. If, for example, we were to increase the money supply, the interest rates will decrease and in turn available income and aggregate demand will increase. This is important for a consumer market, where we need available income to purchase goods and services, and keep business afloat by using their services. With high interest rates, people will be deterred from borrowing if its costs of borrowing exceed the profitability of the investment. With regard to residential construction investment, newly valued constructed houses enter the GDP as the houses are built. A major element of building cost is the cost of short-term borrowing to finance their construction projects. Higher interest rates mean higher costs, which will rationally deter builders from housing starts. This is directly linked to the demand for newly built houses. If the interest rates are higher people will be less willing to take out mortgages and buy new homes. This in turn reduces the demand for NEW housing, and the cycle continues.
ReplyDeleteXiaohan Lin
ReplyDeleteMy money and banking professor staring told this topic about the Fed raised rates this year in the beginning of the semester. And according to the knowledge I learned in Economic 201 the Macroeconomic last semester. Higher interest rate may cause increase in mortgage interest payment. Also, increase in interest rate may cause a decrease in investment. This is because people are willing to put their money in the bank instead of spend, because of the high interest rate. This situation may lead a fall in aggregate demand, cause a recession. In addition, the unemployment rate will be increase. Also, because of the increase in interest rate, banks may think to reduce their profit margin to keep their cost-effective rate same as the time before the raise in rate. When interest rate increase, the bond price decrease. This is because the lower bond payment can be more attractive for the investor compared to save the money in the bonks for the higher interest rate. My suggestion is if the investor have lower coupon bonds in hand, then try to sell them, because the bond starting lost value.
BUS 241-Prabhjot Kaur
ReplyDeleteIf interest rates go up, I would think that the price of bonds will decrease. On a everyday basis, when bond prices go up the interest (yield) goes down. So in the case of the interest increasing, the opposite will happen and bond prices will Decrease. So if people have bonds already, they shouldn't sell them, but instead they should Hold them till maturity because the rising rates won't affect your bonds. As for stocks, it will have little to no affect. But if someone is barrowing money for any type of investment, it will affect you. Since I retest rates will be higher it will also be harder to pay the debt back. In every payment you would be paying more interest then princeple.
Towsif Karim
ReplyDeleteThe rise in Interest rates also means that the cost of borrowing and mortgage rates will be higher. As interest rates go up, bond prices will go down. Stock market investors should be more cautious with stocks as stocks can become less favorable and less earnings can come from them. More people will move away from these investments as banks offer a better interest rate for their investment. I would advise my clients to have a small diverse portfolio, extra cash on them, and to purchase real estate at a low interest rate.
I believe that with the Fed raising the interest rates, the biggest loser will be small businesses and startup companies. As the cost of borrowing money will increase, these small businesses will not be able to contribute as much money into the growth of their company, making it hard to increase their value. Additionally, individuals will have to cope with higher interest rates on their credit cards and mortgage payments, and they would have less discretionary income to spend on these small businesses.
ReplyDeleteWith less money being circulated from consumers through businesses, the stock prices would decrease. This would also result because businesses would have less money for investments and growth opportunities, which would make the estimated future cash flows of the company decrease. As more stock prices decrease, the stock index would decrease, investors would stop investing and there would be a disruption in the stock market.
I believe this would also lead to an increase in unemployment because some companies would use the big bath technique. This technique works by the company having a "fire-sale" of key employees and divisions which they could use as a scapegoat to tell investors that the cause of the recent drop in stock price has been taken care of.
Although a recession is not as likely, it is definitely possible to result from an increase in interest rates, and hopefully Janet Yellen's plan helps boost the economy, and not damage it further.
Zhiwei Liang
ReplyDeleteIf interest rates are rising, bond prices will become discount, below par. Since yields are high, people will be encouraged to invest, thus having an increase investments, stock will rise as well. Having increasing investments, spending will drop, and so real estate and other assets will decrease in value in the immediate short run, but will increase again in the long run after people have sold their shares and made profits from investing.
High interest rates will encourage businesses to make investments. High returns will help companies to improve their research and development which strengthen its market, but at the same time, high returns mean high risks, thus some businesses might fail upon investments and create unemployment as the company go bankruptcy.
If I am an investment professional, I would first analyze my clients’ financial background to see their limited amount of suffer they can take from losses, then ill suggest feasible stocks to invest in. At the same time, ill warn them that constantly increasing interest rate might lead to market breakdown because too many investments is like a snowball falling from the hill, it gets big and might explode somewhere down the hill.
First off I think one large part of the reason for the Fed allowing interest rates to increase is the fact that the economy is doing better. Because the economy is doing better, companies are more willing and likely to invest. As far as bonds go, bond prices and the interest rate are inversely proportional. This means that with an increase in the interest rates bond prices will go down. This makes buying bonds a less attractive option.
ReplyDeleteNow we can take a look at what might happen to stocks. One method of valuing a company is to take the sum of all the expected future cash flows from that company discounted back to the present. To arrive at a stock's price, take the sum of the future discounted cash flow and divide it by the number of shares available. This price fluctuates as a result of the different expectations that people have about the company at different times. Because of those differences, they are willing to buy or sell shares at different prices. If a company is seen as cutting back on its growth spending or is making less profit - either through higher debt expenses or less revenue from consumers - then the estimated amount of future cash flows will drop. All else being equal, this will lower the price of the company's stock. Now again this is only true assuming that a company cuts back. If however the company continues to grow and increases its expenditures, as the Fed expects due to the recovering economy, then an increase in interest rates is not a bad thing.
In conclusion if I were an investment professional I would probably tell my clients to either hold their bonds until their maturity or to sell them before the price drops too much. Invest in the economy. It is a misconception that America is doing poorly economically. As always diversify to minimize risk and assuming you have enough capital look into REITs (Real Estate Investment Trusts) for a safe long term investment.
Joseph Billet
ReplyDeleteBy increasing interest rates, I believe bond prices will decrease. On a regular day, when bond prices go up, the interest yield goes down. When we would switch that order, the opposite would happen.
With stocks, I don’t believe there is necessarily a right or wrong answer. If interest rates go up, it will be harder to grow and expand your company since it will be more expensive to borrow money. By having higher prices to invest and expand your company, you will be expecting lower profits leading to the stock prices to fall. Now, if the interest rates go up, this is a sign that the economy as a whole is doing well, which may lead investors to spend more. Having interest rates go up can lead to investors spending more of their money on stocks and other investments.
With regards to real estate, increasing the interest will decrease the value of it. Having the interest rates higher will make it more expensive to actually buy the real estate, thus decreasing the value of it since the owner will be making less profit.
Rising interest rates will actually sway companies away from making investments because it will cost more at the time to invest. Interest rates make the price of borrowing money more expensive leading an investment to be more expensive.
If I were an investment professional, I would advise my clients to invest in stocks. It is not a clear win, nor will stocks ever be, but it is a route that someone may be able to gain positive cash flow from. If the right investors invest in the same company as you do, and all goes as planned, my client would be very satisfied with their choice of stocks. No one will ever be sure of a stock but with enough research done beforehand you may be able to choose the right one…especially during a time of interest rate spikes.
If prices are raised, bond prices would decrease. They have an inverse relationship. When bond prices decrease, they may look more attractive to buyers.
ReplyDeleteWhen the Fed increase interest rates, stock value can be identified by dividing the sum of a company’s future discounted cash flow by the number of shares that are currently available. Rising interest rates would increases the expenses, which can make the stock market less likely to be invested in. The overall price would be affected by people’s expectations and views on the business.
Real estate and other assets would probably decrease because of the rising interest rates, though not directly. There are several factors that are involved, not just rising interest rates that may affect the real estate and other assets.
Higher interest rates do not encourage businesses to make investments and also may increase unemployment. This is because rising interest rates may make borrowing money more expensive which affects business owners and consumers thoughts on spending their money. When interest rates rise, the less people buy. The less people buy, (the lesser the consumers) the less a business earns. The business then might fire employees because they are not making as much profit, thus increasing unemployment.
If I was an investment professional, the advice I would provide to my clients in a rising interest rate environment is that they should invest in investments that are considered “safe.” Treasury bills and bonds would be the ideal to invest in, while stocks can be risky. But if they already have bonds that they have purchased before the interest prices had risen, I would give them the advice to hold on to the bonds and not sell them. I would advise them to keep the bonds to maturity as if they sell the bond now, the value would not be the same as it was before.
The rise and fall of interest rates have unique effects on the economy and therefore it is probably the most significant tool that can be used to adjust - stimulate/increase or slow down the economy.
ReplyDeleteSince interest rates have been at this historically low rate for a very long time people feel that they will have to be moving upward in the near future. However one of the primary reasons to increase interest rates is to keep inflation in check. When inflation kicks in higher interest rates slow down the inflation. We today are not experiencing high inflation and the benefits of lower interest rates are still very beneficial and necessary to maintain our current economy levels.
If Yellen increase interest rates it would have a negative effect on bond prices and stock prices.
Since new bonds will be offering higher interest the current price of bonds will fall and therefore all the current bond portfolios will lose a tremendous portion of their value.
Stock prices would also fall as companies will pay more to borrow money with the higher interest rates and this would slow down growth in companies causing their earnings to go down and consequently their stock prices to follow.
Companies will stop growing because the cost of new investment in the company would be more costly due to the higher interest rates and therefore employment will be reduced and with more people unemployed there will be less spending and a much reduced economy.
The combination of fewer people working and higher mortgage rates will cause a two prong attack on the real estate market causing a severe drop to the value of real estate.
If I was an investment professional I would advise my clients to sell out of the securities markets and hold on to the cash because with the drop of the real estate market there will be a huge opportunity to purchase great real estate at very affordable prices.
In my opinion small businesses and new startup firms suffer the most when the Fed decides to raise interest rates. Generally, when interest rates increase, so does the cost of borrowing money, which in turn results small businesses to take on a higher financial burden due to the utilization of higher amounts of cash in order to pay off debts and other expenses related to higher interest rates. This will lead to a dramatic decrease in growth and revenue generated by the firm. Inevitably this will influence how large of a dividends corporations can give back to the shareholders and how much the company’s future price will be which is a key factor in determining the profitability of companies. People will also have less income to spend on small businesses due to the fact that higher interest rates will drive up their credit card and mortgage expenses. Again another reason as to why stock prices will plummet. Less money equals less investment in stocks, which eventually results in a decrease in a company’s overall value. And with no money to grow their businesses, corporations lose potential expansion opportunities which impact future net cash flows and ability to keep up with competitors. As this pattern continues, it will eventually take a toll on the stock index and investors will lose faith within the stock market as a whole. History has proven time after time that as revenue decreases and people stop investing in to companies, unemployment skyrockets. All these usually are symptoms that lead to a recession, however if Janet Yellen's plan helps to enhance and recover the economy, instead of hurting it, this can be prevented.
ReplyDelete-Japneet Singh
Pankaj Aggarwal
ReplyDeleteI would like to offer a little different perspective. An increase in the interest rate is not a completely bad thing. It keeps the economy in check and makes sure that the growth we do incur is sustainable. Lower interest rates tend to give consumers more buying power and can thus cause hyperinflation. An increase in interest rates may cause momentary shifts in unemployment, but these changes will be gradual, whereas if low interest rates go unchecked, there will eventually be a correction in the market, which is usually quite abrupt.
Higher interest rates will dissuade businesses from certain investments, though not necessarily away from crucial investments. With rates near zero, businesses and corporations are able to make investments without much calculations or risks. However, by having lower rates are available, businesses will focus on production and less on research and development. If we slow growth slightly, a more innovative market with a more predictable future growth strategy will emerge, which is better than companies that rise fast and plummet even faster.
Though the fed is said to be raising the interest rates, I don’t feel that we should do anything dramatic. The rates will slowly climb over the next few years, it wont be an overnight fluctuation. Locking in a lower rate mortgage before interest rates go up may sound good, but you have to also consider that prices of the property will also be higher before the rate increase. I would advise my clients not to make impulse decisions, and to invest based on the amount of risk they are looking to take paired along with how much yield they would expect.
Lucy:
ReplyDeleteWhen interest rates rise companies with fixed income positions in their portfolios will be adversely affected. Companies who took fixed income positions because they wanted to be conservative, will find that these investments can be risky in an environment when interest rates are changing.
One of the industries that will be most adversely affected is the insurance industry. The insurance industry is highly regulated and insurance companies cannot hold risky investment positions, they must have enough capital to suffice their required capital requirement as well as enough to pay off their claims liabilities. Since insurance companies cannot hold risky positions, many insurance companies have most of their portfolio's in fixed income. When interest rates rise (which they will) insurance companies portfolio values will decrease and they may find themselves in a bind where they may not have enough capital to pay off their claims.
I would tell my clients to try and liquidate their fixed income positions and invest in equities. As interest rates rise people will gain confidence in the economy and start to invest in equities, increasing their prices at the same time that fixed income values are decreasing. If my clients business relied on credit I would tell them that their cost of borrowing will increase and that they should have a plan in place to push those additional costs off to customers. I would advise my client to adequately research their insurance company and be sure that they will continue to be liquid throughout the period of their policy. My main piece of advice will be to understand that rates will increase, there is nowhere for rates to go at this point but up. I would tell my clients that the most important thing they should do is have a plan in place and understand how rising interest rates will affect their business.
Jared Biller Bus 241, Extra Credit Question.
ReplyDeleteAn increase in the interest rate affects individuals, businesses, the stock and bond market, recession and inflation, as well as the real estate market. As the interest rate increases individuals have less spending power, and less goods and services are purchased. Businesses with reduced revenues may decrease their workforce causing a rise of unemployment. A reduction in the purchase of goods and services, and a lower demand for their acquisition, will cause a reduction in prices. While inflation will be controlled as positive consequence of the above, the economy will likely be cast into a debilitating recession.
As to the securities markets, an increase in the interest rate will generally cause a reduction in the price of stocks and bonds. Investors must be warned of these predictable results. As an alternative to risky securities, investors might be drawn to a high yield bank CD, fully FDIC insured, immune from the ill affects of a sliding stock market.
As to the real estate market, first time home-buyers might be discouraged from applying for a mortgage whose high interest rate will question its affordability. They will be concerned of their ability to pay the monthly principle and interest, and bring the real estate market to a halt. As the real estate market is critical to the United States economy, negative predictions are likely.
In summary, while some believe that an increase in the interest rate is a sign that the economy is on the mend, the above illustrations might make one conclude to the contrary.
Thank you all for the thought provoking comments. It will be interesting to watch and see how rising rates will effect the economy and security valuation. All eyes will be on Yellen as she tries to walk the line, balancing unemployment and inflation while moving from a ZIRP to give the Fed more control over monetary policy. We live in interesting times!
ReplyDeleteNew technology news brings to us the latest releases in technological gadgets and items which are available for public information and use. In previous years, emerging technology has been a challenge to deliver to the wider audiences and the general public due to the countless hands that they have to go through such as quality check and huge press releases. useful reference
ReplyDelete"My technology-free day was a nightmare," exclaims one student at the very beginning of her final presentation on technology, nature, and her inner experiences of both. This exclamation has amused me so much that I have repeated it often through the day when describing this project to other students and colleagues at Saint Francis University, a small university tucked into the hills of the Allegheny mountains in central Pennsylvania. spyfone
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