Interest Rates

Interest rate is the amount charged, expressed as a percentage of principal, by a lender to a borrower for the use of assets. (Investopedia)

A friend of mine (who is preparing for her CFA exam to be written in December) sent me a text a few weeks ago inquiring as to what will the implications be on her *fixed income assets if interest rates rose. The theory I grasped in varsity came quickly to mind and I started replying, but I stopped halfway through my reply because I realised that a lot of factors need to be considered about this before one could formulate an answer.

*corporate bonds, government bonds, preference shares, money market accounts etc.

Credit and the costs thereof (interest) are very important in our everyday lives, imagine if we here in Mzansi had interest rates at a range between 0.25%-0.50% which are the current levels seen in the US, I can imagine that consumers would be consuming much more thanks to cheaper cost of debt and companies would be borrowing from here to the moon to finance their operations and expansion. This would be a great state of affairs for the consumers, companies and their owners, not so much for fixed income asset holders as their coupon payments will be much less in a low interest rate environment (holders of fixed income may in time dump these assets and enter the equity markets further fuelling the above state of affairs).

However this is not economically viable ceteris paribus; when one starts to consider things like inflation, employment, ones currency, the economy etc. Central banks will “attempt” to strike a balance between inflation and employment by adjusting interest rates periodically, even reaching extremes in some instances. You see where this is going right? Yep, cycles! The fact of the matter is that interest rates will result in favourable as well as less favourable times for everyone, and as an investor your task is to select assets that’ll survive the changing fortunes of time.

All of this takes me to a well known adage among investors; Never forget the six-foot-tall man who drowned crossing the stream that was five feet deep on average. As Howard Marks remarked; we can’t survive on average, we need to survive the bad days too!


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