Question

The Fed controls interest rates to either tighten or loosen the economy. When the Feds are needing to tighten the economy, they will raise the interest rates. When interest rates are changed, it sends a ripple effect through the entire financial market. When interest rates rise, cost of capital and borrowing increase. Consumers will borrow and spend less. This will lead to a slower economy and help to hedge inflation. However, the change in interest rates can affect the market values of different assets which can affect the return for investors and the overall profit for companies. A rise in interest rates will also cause asset prices to fall. When prices fall, yield will be affected. This is what interest rate risk is. When rates increase, bond prices fall. When rates decrease, prices will rise. When prices fall, the yield to maturity will increase. According to the SEC (2019), bond maturity and coupon rates will affect how price changes due to a change in interest rates (p. 3). So, the higher the coupon rate, the lower the interest rate risk. The opposite is true when the coupon rates are lower. The lower the coupon rates, the more the market value will be affected. It will likely decrease more for bond with lower coupon rates. Market values will always vary throughout the life of the bond, depending on what happens to the rates. According to Mike Patton in an article written in Forbes magazine in 2013, when rates fall, bonds are sold at a discount. They are worth less than their face values. Investors should hold onto their bonds when rates rise to keep from selling bonds at a discount. Assets with shorter maturities will be less affected by a change in interest rates and same with their market values. Do you agree or disagree with this statement?

Answer 1

Every kind of financial asset is going to be effected with the changes in interest rates. Comparatively, the assets which have higher maturity gets more effects than the assets which are less life span. I agree with the statement that at higher interest rates the bonds are selling and vice versa. Instead of selling the holdings, it is better to hold them for some period till the interest rates declines.

The reason for higher effect on long term instruments than short term instruments, the cumulative value is going to be higher for long term bonds than short term bonds or interest bearing instruments.

Hence, I agree with the give statement.