( ).
The change in interest rates has important implication for the stockmarket prices of bonds, which pay a fixed rate of interest: fixed-interest securities, of which the traditional gift-edged securities issued by the government are the most familiar though companies also issue fixed-interest bonds. It works like this.
Gift-edged securities are a form of IOU (I owe you) or promissory note issued by the government when it needs to borrow money. The government undertakes to pay so much a year in interest to the people who put up the money and who get the IOU in exchange. Normally the government agrees to redeem the stock at some date in the future, but to illustrate the interest rate mechanism it is easiest initially to take an irredeemable or undated stock, which does not have to be repaid.
The original investors who lend the money to the government do not have to hold on to the IOUs. They can sell them to other investors, who then become entitled to receive the interest from the government. Suppose the government needs to borrow money at a time when investors would expect an 11% yield on a gift-edged security. It offers $ 11 a year interest for every $100 it borrows. The investor is prepared to pay $100 for the right to receive $11 a year interest, because this represents an 11% return on his outlay.
Then suppose that interest rates rise to a point where an investor would expect a 12,5% return if he bought a gift-edged security. He will no longer pay $100 for the right to $11 a year in income. He will only be prepared to pay a price that gives him a 12,5% return on IIIs outlay. The right price in this case is $88, because if he pays only $88 to receive $11 a year in income, he is getting a 12,5% return on IIIs investment. So in the stockmarket the price of the gift-edged security that pays $11 a year interest will have to fall to $88 before investors are prepared to buy it. The original investor who paid $100 thus sees the value of his investment fall because of the rise in interest rates. Conversely, the value of his investment would have risen if interest rates had fallen.
To summarize: If interest rates on securities go down, bond prices or prices for securities go up, and vise versa.
VOCABULARY NOTES
A promissory note
To put up the money
To redeem ( )
Irredeemable stock
To hold on (to smth) -, -
Vise versa .
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1.What are different types of investment and what are the corresponding markets?
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