Impact on asset classes
Cash
The return on cash-based investments will fluctuate broadly in line with the interest rate. If interest
rates are low cash deposits will be unattractive as in real terms (taking into account inflation) they
may be making a negative return.
Fixed Interest Securities (Bonds)
There is an inverse relationship between bond prices and interest rates – as one goes up the other
goes down. When interest rates go up, the prices of bonds fall so that they produce a greater yield
to reflect the higher interest rates.
Equities
Equities generally benefit from low interest rates, because company profits are usually higher as a
result of the reduced cost of borrowing and higher demand for the company’s goods and services.
Questions - Use Your Note Taker To Jot Down Ideas / Calculations
Gemma owns fixed interest securities. If interest rates were to rise:
a) their yield and their value will both rise.
b) their yield will decrease and their value will increase.
c) their yield and their value will both fall.
d) their yield will increase and their value will decrease.
D)
There is an inverse relationship between interest rates and the value of fixed interest securities – if
one goes up the other goes down. There is also an inverse relationship between the value of fixed
interest securities and their yields – higher value = lower yield. So if interest rates were to rise,
values would fall and yields would rise.
- Further Study Text: Pages 121-122