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Elements Of Rising Interest Rates

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As inflation surges, people are always keeping a watchful eye on the changing figures. It is quite natural that every year the prices of goods and goods are going to increase. This is a given, considering the rising population, dynamic trade, fluctuating economic scenarios, and very limited resources. But at the same time, the public authorities and the central bank of any country needs to try hard to keep this rise within the realms of reality. Sharp rises in prices or hyperinflation can doom an economy. To break it down very simply, inflation reduces the value of money. This happens as inflation reduces the purchasing power of one unit of currency.

As employment levels and wages rise, people have more money to spend and prices will tend to rise as a consequence of the increase in the money supply. This is the basic cause of inflation, and while inflation levels that are held in check can lead to sustainable economic growth, unchecked inflation levels can spell economic disaster as the economy can literally collapse under its own weight leaving hard-working citizens with money that has had its value and buying power eroded. Understandably, the Federal Reserve and all other central banks will monitor inflation levels very closely, and one of the best means to combat inflation levels is by raising interest rates. For anybody who is looking into rising interest rates; visit read full article.

When interest rates are low, you may not be earning as much money on your savings but it is far easier to borrow money for a house, business, car, or any other form of credit. It is this ease of access to new money that can help to the cycle of inflation. However there can come a time when inflation levels are rising too far too fast, and instead of creating economic growth in a sustainable fashion it may give rise to an out of control economy in overdrive that may give rise to something that Alan Greenspan called 'confiscation by inflation,' meaning that the value of every person's money is eroded by the large increases in the overall money supply.

Tips and Tricks About Rising Interest Rates

Raising interest rates will keep inflation in check by tightening the credit markets and making more difficult to have access to new money, thereby shinking the growth of the monetary supply and making harder to have access to loans. The relationship between interest rates and inflation levels is an essential one to understand if you're a forex trader, because keeping tabs on these simple metrics can help you identify where the general trend of the currency is and whether you should be buying or selling. A lower interest rate will mean that your money doesn't grow as quickly as a coefficient of time, however, it can also say that the country is experiencing economic growth as loans and credit are more easily available. This means the value of a currency can rise in the foreign exchange markets despite the higher inflation levels. Click on this URL;

Any investor investing in bonds is looking at a fixed return after a period of time. Say for example an investor invests $1, 000 in a Treasury Bill with a 10% yield. That means the investor will get $1, 100 after one year. If we assume that there's no inflation, it translates into a straight 10% return on his investment. But if we assume an inflation of 4%. This means his purchasing power has reduced, this takes away a chunk from his return of 10 %, and now his actual return is only 6%.

This example emphasizes the need for the investors to examine the difference between a nominal interest rate and a genuine interest rate. The real interest rate affects the level of inflation. Hence it must be closely followed. Unfortunately, most of the investors look only at the nominal rate and forget about the actual purchasing power.

Bonds are sold at a premium, discount or at par. When the interest rate or coupon rate of the bond is more than the current interest rates, it will sell at a premium. When the coupon rate is the same, it will sell at par, and when the coupon rate is less than the current interest rate, it will sell at a discount. The price of a bond, basically, is the present value of all its future payments. This present value is calculated by discounting the future payments with an appropriate discounting rate, usually the prevailing interest rate. Prevailing interest rate is used because it is the return you get by just keeping your finances in the bank. So usually bonds with a higher incidence of return than the prevailing interest rates are sought after.

The main parameters for making the purchase decision of any bond will be the bond price and its yield value. Both these parameters are influenced by the prevailing interest rates. A good investment grade bond might turn into a junk bond due to variations in the interest rates corresponding to the inflation.

Another key point is the call option that companies have hardwired into their bond. Suppose, due to inflation, the interest rates drop below the coupon rate, the company issuing the bond has to give more money to the investors. They can simply find a cheaper source for their funds as the prevailing interest rates are less than the interest that they're paying to their investors. The company may exercise the call option and return the investors their money prematurely, and then borrow from a cheaper source. This drop in interest rate may likewise be caused by inflation.

These are just some effects that inflation has on bonds. To sum it up, inflation first reduces the effective return on a fixed income or fixed return instrument. It likewise affects the interest rates which in turn determine the complex bond pricing and yield relationship. Also adverse changes in interest rates caused mainly by sudden unanticipated inflation may cause the companies to draw the bonds prematurely, denting the investment plans for many investors who're looking for fixed income, and leaves them adrift.

Careful planning, a bit of foresight, and a weather eye on the interest and inflation horizon, an investor can effectively plan his bond investments, and even make a neat profit with these ever-changing tides and winds.

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Chloe Devitt

Saved by Chloe Devitt

on Aug 26, 14