Business cycle impact on asset classes
Fixed interest securities
• When the economy is booming, people are prepared to pay more for goods and services.
This pushes up prices, generating inflation and higher interest rates.
• The yields from existing fixed interest securities will need to be higher to compete with
other investments, so their price will fall. This is also due to new bonds being issued with
higher interest rates, so the demand for existing bonds fall.
• When inflation and interest rates are low and falling, the income from fixed interest
securities becomes more attractive. In a recession and the early stages of a recovery, the
prices of fixed interest securities should increase due to falling interest rates.
Equities
• The prices of equities in general rise and fall with the upturns and downturns of the
economy. However, the speed and degree to which they individually respond to changes is
varied.
Questions - Use Your Note Taker To Jot Down Ideas / Calculations
In a boom period of an economic cycle, the most likely impact on the price of gilts is that they will:
a) rise and then level out.
b) fall.
c) rise.
d) stay the same as they were in a recession.
C)
During the boom phase of the economic cycle the government will raise interest rates to try and
slow down the economy and stop it from overheating. There is an inverse relationship between
interest rates and gilt prices – generally if interest rates rise the price of gilts fall, this is because the return they are providing above the base rate of interest is less.
- Further Study Text: Pages 114-115