Interest Rate Sensitive Stocks & Sectors List

Details about the List of Interest Rate Sensitive Stocks & Sectors and how their stock performance is impacted by interest rates
In this article, we will talk about the list of stocks and the sectors which have a direct impact on the stock price movement based upon the interest rate changes.
In our past article, How Interest rates affect stock prices, we have explained the how the share prices move in case of interst rate changes - the article carries quite a few good examples for anyone to understand the share market performance and its interest rates dependency.
Continuing further, our focus in this article will be to highlight only those stocks, shares and industry sectors, which are heavily dependent on interest rate price fluctuations. So let's begin with the list of Interest rates dependent stocks and shares.

List of stocks and sectors with dependency on interest rate changes

First, let us look at the root cause of this topic - why should you worry about any share, stock or industry sector being dependent on interest rates? Basically, its your money. You are investing it in stocks and shares, and acros various industry sectors. The returns generated by fluctuating share prices depend upon lots of micro and macro-economic factors and interest rates is one of the prime factors for that. Hence, it is good for any individual trader or investor to know about dependency of stock prices and their sensitivity to interest rate changes. So let's start with the list.

The first on the list of Interest Rate Sensitive Stocks & Sectors is the Banks and Financial Industry Stocks, for obvious reasons. Now, it sounds obvious to keep banks and financial institutes at the topmost position, but in my personal opinion it is something that needs to be looked upon properly.
Banks work on simple principle - collect money from depositors in form of savings (at a lower interest rate) and offer loan to borrowers (at a higher rate) and keep the differential as profit. So, as and when any interest rate changes occur, banks and financial institutions are expected to be hit first. However, it needs a rethink. When interest rates rise, the banks usually increase both the lending rates as well as the deposit rates. Usually, the deposit rate increase is less compared to the lending rate increase, which again goes in favour of the bank. Hence, although there are minor drop in the bank index or overall banking and financial sector share prices, due to this increase being applied to both lending and deposit rates, banks dont suffer that much. Hence, if the fundamentals of the banks are strong, then such increase in interest rates can offer good buying opportunities to investors, with a long term view.
But you need to be careful about the overall business scenario as well - in case the macroeconomic interest rates go really high, then there is less liquidity in the market as people spend less. Hence, even bank stock may not perform that well, despite the deposit and lending rate differential.

The second on the list of Interest Rate Sensitive Stocks & Sectors is the Real Estate Sector and Property Stocks, like those of construction companies or infrastructure development companies.
The reason for this real estate sector being impacted depends upon the country's economic status. If the real estate market in a country is such that people can buy property only by taking a loan (because of high property costs), then this real estate sector gets very much affected by the interest rate changes. If interest rates increase causing costly loans, then demand for real estate (usually purchased on loans) go down. This leads to a fall in real estate share prices. On the other hand, for a loan dependent economy, if interest rates decrease, then it is a positive for real estate market, as more people tend to take loan at lower interest rates.
However, for a country which does not have loan dependency, the interest rate changes does not usually have much impact on real estate share prices.

Third on the list of Interest Rate Sensitive Stocks & Sectors is the Automobile Industry Stocks - this again depends upon teh country's econmomy. If majority of the vehicles are purchased on loans, then this sector gets badly hit by increasing interest rates.

Fourth on the list of Interest Rate Sensitive Stocks & Sectors is the Capital Goods Stocks & Sector, which again depends upon the market demand and supply. In case of high interest rates, the overall demand in the market goes down and hence all the companies in the capital good sector take a hit as their products, services and other offerings see less demand. There is a speculation about less growth and hence these stocks too take a hit.

Other than the above mentioned four sectors, there is company specific interest rate risk which should be checked by all investors. For eg., there can be a company listed on NYSE which may have a market cap of say 10 million, but it may have an outstanding debt or loan of 15 million. Hence, the loan amount to be repaid is higher than the actual market cap valuation of the company. This company can belong to any sector, but its share price will be hit severly if the interest rates increase. Because of increase in interest rates, it will mean that this company will have to pay more interest on the outstanding loan amount and hence this poses a negative situation.

Therefore, to summarize:
1) Usually, Banks, Financial Sector companies, Real Estate, Auto and Capital Goods sector are the ones which get affected by interest rate changes.

2) Apart from the above, the investors should also look at the company outstanding loan and debt amounts

3) It should also be compared to the market valuation of the company based upon current stock price, before making any investment

Buying Car on Loan: Margin Money increased

Few weeks back, we has reported that for Auto Loan Car Loan: Interest Rates will be decided by Credit Profile. Now, people who were happy to thrive on loans for buying the luxuries of life on loan will find that getting a Car Loan or Auto Loan has become more demanding and more difficult.

The reasons are many.
First, the interest rates has risen significantly. Though Car Loan Auto loan interest rate is comparitevely cheaper, beacuse the car itself is used as a collateral, but it is a luxury or accessory which depreciates in value as the time goes by. So, the high rates of interest have hit the car buyers on loan significantly.

Second, the credit profile or Credit Rating of an individual will be deciding the interest rates which you need to pay. That again is subjective and depends on the loan offering organization.

Third, there is a requirement for margin money -this is the margin money which needs to be brought in upfront. The bad news is that major loan offering players like the Private sector banks have quietly hiked the margin requirement by as much as 10 percentage in the past few weeks.

What this means, say if you want to buy a mid-size luxury car which may cost somewhere like 500,000. So apart from the loans, you are required to put in some money upfront from your side. Some weeks back, it used to be only 5% and now it has gone up to 15% or 20% by some banks. It means that if for a 500,000 Rs. car, initially you were required to pay only 25,000 as margin money from your side and rest through the loan. But now you will be required to pay 75000 or even 100,000 as margin money, so your loan amount available to you will be less.

Why is this happening
Well, banks are running for cover due to the global economic turmoil. They are running short of cash. The interest rates have increased so banks need to keep a lot more money as reserve with the central banks of the respective country. Hence, there is a problem of liquidity in the market and therefore not much money is available. So the banks are expecting the loan borrowers to shell out more money from their side and take loans of smaller amounts. However, these loans are offered at high interest rates.

TOI had an article in last few days, where it mentioned that "for a car buyer is that he should shell out 60,000 upfront for a compact car as against 20,000 earlier and increases correspondingly for bigger cars. Till recently, car financiers used to finance upto 100% of on road price of car.
"This is not all. In most cases, car financiers have brought in tighter disbursal norms, making a purchase a Herculean task. I know of a case in Coimbatore, where a buyer was asked to show property in his name to avail of a loan for a small car. And more so, after all paper work, the lender disbursed only 85% of the car value," sources said. A section of market feels that rising interest rates actually don’t hurt sales that much. A 50 basis points or half per cent increase on a one lakh rupee car loan for a tenure of three years would translate into a monthly of a mere Rs 36, they say.

Banks Inflation & Interest Rates

RMathew has posted a nice article on his blog, mentioning that the Interest earned on the savings bank account should be exempted from tax, as the interest rate earned in the savings bank account is way below the rate of inflation.
To understand the concept, here is a simple example.
You have a savings bank account with XYZ bank. The bank pays you an interest of 3.5% per annum, as per the RBI or Reserve Bank of India policies.

Imagine you have 100 Rs. as spare for a year. You have 2 options:
1) Put the money in your savings bank account and let it earn 3.5% rate for 1 year. So at the end of the year, you will get 103.5 Rs. as returns

2) Use that money to buy something you need, say half a kilo of tea leaves. You may not use the tea leaves immediately, but after 6 months to 1 year, you may use it.

Now, the interesting case is with the inflation. Inflation measures the dearness or Mehengaai (Hindi). So, if the rate of inflation is 7%, then what costs 100 Rs. today, may cost 107 Rs. a year later, OR to be more precise, the present price as compared to last years price has increased by 7%, as inflation is measured on historical values.

Coming back to the example above, suppose you put your money in the bank and take out 103.5 Rs. a year later. You will find that the tealeaves that you could have bought for just 100 Rs. a year before are no more affordable, even with the 103.5 Rs. because due to inflation, the price has increased to 107 Rs.

Hence, this brings us to the concept of Real v/s nominal interest rates:
Real Interest Rate = Nominal Interest Rate – Inflation

What the bank is providing is only Nominal Interest rate (3.5%). What you actually get, in terms of purchasing power, is the Real Interest rate. In the above example, the Real interest rate will be negative, as Nominal – inflation = 3.5% - 7% = -3.5%

Hence, in essence the money you deposit is loosing value for purchasing power, due to inflation.
Moreover, even though you are earning nominal interest, you have to pay tax on it. So 30% of 3.5% is 1.05%. Therefore, after tax, all you get is just 2.45% which is well below the inflation figure of 7%!
Mathew is expecting the government to stop charging interest rate on this nominal value earning, as it is not a real profit. He also suggests that the money should not be kept in the savings bank accounts, but should be invested.

However, the question is about certainty. Today, everyone is talking about inflation, because it is high at 7%. While it was down at 3.5% to 4%, no one noticed that. Government cannot make a period based ruling, that if inflation is higher than the interest rate, then tax will not be charged. It all depends upon the market timing and that works randomly.

What can the investors do to fight such indirect losses?

Unfortunately, there is no sure shot way to fight inflation. Countries like Zimbabwe, which are witnessing a crisis have seen inflation at the rate of 20000% in one single year, if you want to talk about the extreme cases. However, the best bet is to keep money in Fixed Deposits, or get into tax saving infrastructure bonds, as explained in this article: Are we using the banks account effectively?

Unfortunately, there is no such thing like sure to get money – even with the bank rates. The Fixed deposit bank rates change ever now and then.

Though they are less volatile, but changes are expected. Don’t expect the government to do anything – you know who are sitting to make laws for citizens.

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Dollar-Yen Forex at 3 year low: More rate cuts?

The dollar diplomacy seems to be breaking. There is nothing that is stopping the dollar from touching the record lows.
Despite so many measures, despite so many rate cuts, the dollar continued its decline and hit the 3 year low against the Japanese Yen.

These are strong signals that the Fed may go for another round of interest rate cut, anytime. The dollar declined to a three-year low against the yen on speculation the Federal Reserve will signal plans to keep cutting interest rates to avert a recession.

Not only that, the dollar is weakening against the Euro as well. The dollar fell last week against the euro by the most since December after Fed Chairman Ben S. Bernanke said some small banks may fail and unemployment will increase.

The dollar weakened to a record low of 1.0323 Swiss francs from 1.0412 and declined to 5.2062 Norwegian kroner compared with 5.2131. Against the Canadian dollar, the U.S. currency dropped to C$0.9856 from C$0.9878. It’s all going against the dollar for the moment. No doubt that is will surely hurt the export dependent economies like India and China significantly.

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Rate Cut: SBI, Canara, Union Bank, Bank of India: What’s happening?

It’s the government backed PSU banks that have again taken the lead to fight it out in the open market competition. The state run banks have gone for a 2nd round of rate cut giving major relief to borrowers. It doesn’t appear to be the problems of the slowdown of economy, but more to be the instructions from the government, otherwise, such a synchronized move when 4 PSU banks simultaneously go for a rate cut at the same time is not just a mere coincidence.

As per the news:
State Bank of India, Canara Bank, Union Bank of India and Bank of India — on Wednesday announced a cut in their benchmark prime lending (PLR) rates. For SBI and Canara, this is the second cut in less than a fortnight.
RBI, keeps on giving the reference to inflation and has been avoiding the rate cut. But this appears to be an indirect attempt to ask PSU banks to cut the rates. But as far as my knowledge goes, this kind of strategy may not work well. The consumer confidence is low, there have been less spending, especially after seeing what is going on in the US and UK. The interest rate differential between US & India is too high, almost around 5%.

Such indirect moves of forcing PSU banks to cut rates MAY keep up the loan markets and maintain the borrowing levels, but it will definitely not bring up the spending levels of the customers, as was the case during the past few years. Probably that is the reason that the second largest bank, and the largest private bank of India, ICICI Bank has not yet gone for a rate cut.

The biggest player, SBI, has announced a 25-basis point cut in the SBI advance rate (SBAR) to 12.25%. The rate cut will come into effect from February 27. Barely a week ago, SBI had cut its PLR by 25 bps to 12.50%. SBI, which is taking the lead, met heads of some of the other nationalised banks, including Canara Bank, Punjab National Bank, Bank of Baroda, Union Bank and Bank of India, to discuss a possible cut.
Bank of India too lowered its PLR by 50 bps to 12.75%, a week after it lowered rates on vehicle loans by 50 bps, educational loans by 100 bps and consumer loans by 250 bps. The new rate cut would lower these rates by another 50 basis points.

The new rates would come into effect from Feb 21 for Union Bank of India and Bank of India. Canara Bank has also cut its prime lending rate by 25 basis points, to 12.75%, effective from Feb 25.

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Interest Rate Cuts: US, UK and India

It seems to be an almost certainty, that there will be further rate cuts in US, UK and India. There are strong signals from Fed, Bank of England as well as Reserve Bank of India, that there may be interest rate cuts in the coming few weeks.

Yesterday, it was Ben Bernanke, The Fe Chairman, who set the outlook for the coming year, and clearly hinting that the Fed is very open to cut the rates further to help the struggling US economy recover from the so called fear of recession, which some experts believe is unavoidable. How bad the US economy is is clear from the measures taken by US government recently – offering a tax rebate, Warren Buffet making an offer to reinsure municipal bonds & Fed reveals plans to help mortgage defaulters - Just to name a few.

In UK, we have the same story. The Bank of England governor has already expressed deep concerns over the falling standards of living in UK due to substantial price rise in food and fuel costs. Reuters yesterday reported that there is a strong possibility of 2 more rate cuts by Bank of England to bring some clam to the struggling UK economy.

In the emerging markets, India’s Finance Minister and Reserve Bank of India Governor is giving strong signals for a rate cut. The expectations are that in March, there will be some relief from the growing interest rates. Though in a recent statement, the RBI governor had left the field open to the banks to battle it out and many banks in India have deducted their rates for house loan, car loan, etc.

But the latest signal is the fuels price hike by the Indian government. A rise of 4% in petrol (Rs. 2) is the strongest signal, that analysts believe, is sufficient enough to indicate the government is seriously considering a rate cut. Let’s see what goes on – expectations for rate cut are in March.

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SBI Bank rate cut (SBI Home loan rate Cut)

SBI, the largest bank of the world in terms of number of branches has joined the other PSU banks like Canara Bank and Allahabad Bank, along with private sector bank like HDFC in cutting the rates. The PLR or Prime Lending Rate of State Bank of India or SBI has been slashed by 0.25% or 25 basis points.

It has been brought down from 12.75% to 12.50%. This will make almost all of the loans offered by SBI cheaper, that includes house loans (home loans) & car loans offered by SBI.
As per the news from PTI (http://www.ptinews.com/pti%5Cptisite.nsf/0/A28D4802C9AB8015652573EC002E09A4?OpenDocument):

The reduction in PLR is likely to moderate lending rates for all category of borrowers, including housing (floating rate), corporate, car loan etc. The decision follows the up to one per cent cut in housing and consumer loan rates announced by Canara Bank and Allahabad Bank.

Housing finance company HDFC and PNB Housing Finance too had reduced interest rate on housing loan. While HDFC reduced its RPLR by 0.25 per cent effective February 1, PNB Housing Finance slashed the rates by 0.5 per cent.

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UK Rate Cut: Mortgage lenders cut mortgage rates

Following the US Fed decision to cut the interest rates big time, the Bank of England has followed suit. The UK based Bank of England has also cut the interest rates by 25 basis points or 0.25%.

The mortgage lenders in UK are pledging that the rate cut will be passed on to the customers but it may take some time. So if someone has a mortgage of value £100,000, his obligations will reduce by around 16£ per month or £192 per year.
However, 55% of UK mortgage borrowers are on fixed rate mortgage, so there will be less impact of this 25 basis point rate cut in UK. There will be rate cuts for other types of mortgages like Tracker Mortgage, but the cut may be less than 25 basis points.

On the other side, the effect of rate is is compensated by other developments in the UK mortgage markets. It is learnt that two of Britain's biggest mortgage lenders, Alliance & Leicester and Britannia building society, have doubled the minimum deposit demanded from first-time buyers in the latest sign that banks are anticipating a downturn in house prices.

This is the second such rate cut announced by the Bank of England in last 3 meetings. Though the economic analysts have warned that there was unlikely to be further relief for homeowners in short term, despite evidence of a weakening economy, given the Bank's warning yesterday about inflation. All this is leading to only one single destination- the world economy going into a major recession. No doubt, the world is a global village, and everything moves in sync!

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Allahabad Bank & Canara Bank cut loan rates significantly

Initial Speculations were about Bank of Baroda, Bank of Maharashtra and Union bank going for a rate cut in home loans floating interest rates. But it was Allahabad Bank and Canara Bank who has taken everyone by surprise by suddenly declaring a significant rate cut in their various loan offerings.

The rate cut for Allahabad bank will be effective from from February 10 and the rate cut for Canara bank will be effective from February 7.

Another good news is that the rate cuts will be effective for both the existing and the new customers, contrary to what HDFC had to offer – HDFC home loan rate cuts only for existing customers. Another significant part is that these nationalized banks have deducted the rates for almost all kinds of loans unlike HDFC doing it only for home loan. Moreover, HDFC rate cut was only 25 basis points (or 0.25%), while Allahabad Bank and Canara Bank have gone for a rate cut varying from 0.25% to 1% across different loan segments. Loans like education loans are expected the get cheaper by as much as 1%.

Here are the news items from the sources:

(http://in.reuters.com/article/businessNews/idINIndia-31778720080205) - State-run Allahabad Bank said on Tuesday it had reduced its interest rates on retail lending by 50-100 basis points following the reduction in its cost of incremental funds.
The rates on deposits having a tenure of 2-10 years have been reduced by 25 basis points while rates for deposits of 61-180 days have been raised by 75-100 basis points, it said in a statement.
Shares in the bank ended 4.65 percent up at 121.45 rupees in the Mumbai market.

(http://www.thehindubusinessline.com/2008/02/06/stories/2008020652030600.htm):
Canara Bank reduced its home loan rates by 25 basis points across the board. A bank release said the reduction would take effect from February 7. The reduction would be applicable for existing floating rate borrowers as well, the release added.
The revised rates for loans up to Rs 20 lakh for five years would be 10 per cent. The rates for loans up to 10 years would be 10.25 per cent and 10.50 per cent for 25 years, the release said. For loans above 20 lakh, the rates would be 10.25 per cent, 10.50 per cent and 10.75 per cent, the release added.

Other big banks like SBI and ICICI bank are still silent. I do not expect them to keep their stand for long. Hopefully they will also have to give into the market pressure and reduce their home loan rates. Let’s hope for the best

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Home loan Rate cut by Indian banks?

After HDFC bank decides to go for a rate cut in their HDFC bank home loan rates for the new customers instead of the existing ones, it was once in last 5 years that a bank in India has actually reduced the floating home loan rates for the first time ever since 2003.

After RBI declared that it is not going for a rate cut and clearly told the banks that the market is open for them to battle it out, it was HDFC bank that took the initiative and cut the home loan rates. However, now other banks are expected to follow suit.

As per the news from CNBC webcast, Bank of Baroda and bank of Maharashtra are planning to go for a home loan rate cut in the floating home loan segment. Following the move by HDFC, there have been many speculations about the rate cuts from other banks – especially the private banks.
Though ICICI bank has clearly denied the possibility of a home loan rate cut in any form, Bank of Baroda (BoB) and bank of Maharashtra (BoM) are said to be in the deciding phase about whether to go for a rate cut or not. There are also rumors that even Union Bank might come up with a rate cut.

If that happens, then it will be a big respite for the floating rate home loan borrowers who have witnessed only an upward trend for the home loan rates in the last few years. Though the news is not confirmed, still in rumour stage, let’s hope that thing work in favour of the common man.

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Forex Currency Trading: How forex rates are determined?–2

This is part II of the article Forex Currency Trading: How forex rates are determined?– I. Please read the first part before proceeding with this one

Another reason for forex rates to move is due to interest rates. Suppose that in Europe, the interest rates are at 4% per annum, while in India, the interest rates are 10%. What will happen on the investments front?

People from Europe (including fund managers, FII, investors) will rush to India and start investing in Indian fixed income products like Bonds, etc. (provided they are convinced about the stability of the country and good returns). This will create a big demand for Indian Rupee, because Indian investments can be made in rupees only. Hence, the forex rates will start changing, so as to accommodate for this demand and supply. The Indian rupee will start becoming stronger as compared to European euro, and the process will continue.

The government of India, the RBI is struggling with this problem at present. The rates in US are at record low – another cut of atleast 25 basis point is expected by today evening. But the interest rates in India are high. So there is a big inflow of dollar in India, which is creating a big demand for Indian rupee and hence the rupee is getting stronger.
The government can as well cut the interest rates, but that will affect lots of economic factors and prices of other basic commodities and primarily, the inflation. Hence, the equilibrium is established automatically by the market factors, the demand and supply of commodities, the interest rates, the inflation and other market forces.

Can anyone predict anything about the future? Atleast I would not claim anything. Right from the prices of commodities, the production of commodities which ultimately depends upon the weather conditions, the government stability and its rise and fall, the interest rates, the entire market and the investors confidence and behaviour. Hundreds of thousands of factors play a role in forex price determination. No body can be certain about anything.

Forex market is said to be the most active market across the globe. It is the only market in the world that runs 24 hours non-stop. Share markets have their timings, bond markets have their timings, but forex markets never sleep. I was in Mumbai last year with a friend of mine who trades in Australian dollars and US dollars for a big investment bank. At 2:30 at night, he got a call from US counterpart, about a possible political issue in Australia. Immediately, he rushed to his office to check his holdings in Australian dollars. Later, the news appeared to be rumour and he returned at 5:30 am, just to return back to the office at 8:30 am. This is what is called the real dynamic market!

All one can do is make a short term prediction for movement of forex rates. It is very easy for me to say “Dollar Rupee will remain in the 39-41 range during this month.” Making long term predictions is difficult.

India has already lost 20 lakh jobs in the different export sectors due to dollar rising – this is the official figure. The unofficial figure can be as high as 50 lakhs. And an export worker loosing the job means a low income family being deprived of its livelihood.

Till last year, IT companies use to make the index like Sensex run. This year, they have pulled it down significantly. Infy trading at 2100 levels touched lows of 1550 – a clear loss of 25%. All courtesy of the Dollar rupee exchange rate. No one can predict the rates and its impact in the long run. All one can do is keep making bets with one’s assumptions and speculations. If you ask me where is the dollar rupee rate headed, my answer would be “I don’t know”. If you want to listen what will make you feel happy, then there are thousands of “investment advisors” and “business experts” waiting to serve you.

Here is an example of how forex rate change collapsed a company, which was run by a noted business tycoon!

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DCF Analysis – an example - III

This is part III of the article DCF Analysis – an example. Please read the article from the first part before continuing with this one

This return of 13.47% was accumulated over a 3 year period. Hence, to make a comparison, we should annualize it.

To understand how annualization works, take this example.
You invest an amount of 100 for 3 years at the rate of 10% and don’t withdraw anything in between. How much money will you get at the end of 3 years?

First year principle = 100
Your first year income = 100 * (1+ interest rate) = 100 *(1+10%) = 110
Second Principle = First year principle + First year interest income = 110
Second year income = 110 *(1 +10%) = 121
Third year principle = second year principle + second year income = 121
Third year income = 121 * (1+10%) = 133.10

Hence, at the end of 3 years, you get a total of 133.1
Actually, the simple way to calculate this is the following formula:
Final Value = Initial Principle * (1+ annual interest rate) ^ no. of years
= 100 * (1+10%) ^3
= 133.10

Hence, if we know final value, then we can calculate the effective annual interest rate in reverse calculation as follows:

Final Value = Initial Principle * (1+ annual interest rate) ^ no. of years
So annual interest rate = (Final Value/Initial Principle) ^ (no. of years) – 1

Now, for 13.47%, the annual interest rate comes out to be 4.3% only.
To cross-check : 100 * (1 + 4.3%) = 113.467 = 13.46%, which matches the value exactly.

On the other hand, for simple plus-minus calculations, we received a profit of 23.76%. Corresponding calculations give an annualized return of 7.36% - which is incorrect as compared to the correct figure of only 4.3%.


Hence, if you take the realistic time value calculations, you will observe that the simple plus minus calculation will always give a highly bloated and incorrect value for profit calculations. We MUST understand this very clearly.

---Modified after comment from Nilesh-----
The reason why I gave a detailed example here was because the 4.3% annual return that you are actually generating on your RISKY stock market returns (over and above the risk free rate of 9%), is this extra percentage justifiable with respect to what is offered by the RISK FREE bank accounts or bonds?

Secondly, We have considered all the investments with POSITIVE RETURNS. Not a single stock investment has been assumed to give negative or loss making returns. The moment we take negative returns even for 1 or 2 stocks, the 4.3% will come down drastically.

Thirdly, this article is not only to compare your returns with those Bank accounts and bonds, but to actually learn to compute the right way of profit/loss.
---Modification Ends -----

That is why I always insist on making correct calculations and then see what you have done in the past, what your positions are in the present and would you be interested in avoiding these mistakes for the future.

Tomorrow, I’ll continue with some more parts of options trading tutorial.

Have questions, please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.

You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.

How Interest rates affect stock prices – I

This article is based upon the request from Bhavik (left in my previous article on Financial/ Investment Projects failure, who has asked for explaining how the interest rate changes affect the stock market prices.

How do the interest rates affect the stock prices?

As I’ve explained in my previous articles, people invest money in different instruments for the sake of getting good returns. As a matter of fact, there are 2 aspects of investments. One is the return, other is the risk or loss. (For the moment, we’ll leave aside the third aspect namely, transaction costs).

Individuals have a psychological bias – they want MORE returns and LESS risk. To put it in simple words, they want to MAXIMIZE returns and MINIMIZE risks.

Hence, the investors look for investment products which give them better returns and leave them with less risk. A savings bank account is an investment product which gives you assured returns. So is the stock investment. However, the major difference between the 2 is that one is considered risk-free while other is full of uncertain risk.

Now, in case the interest rates are high, say 8% or 10%, the investors would love to put their money in the bank accounts – which are considered very safe – no risk at all. Though the stock markets have had a fantastic run in the last 6 years, it is a fact that stock market returns in the range of 10-15% have been considered extremely good. So, investors who can get around 10% returns risk free in savings bank account, would like to save money in bank accounts, instead of putting it in the risky stock market. Hence, the stock market investments go down when the interest rates are higher.

Any government bodies, like Fed in US or RBI in India, are the regulatory authorities which deal with interest rates. Since they are government bodies, they have the power to change the interest rates anytime as per the economic conditions or market requirements.

Also, the interest rates defined by them, become the benchmark for different types of loans. Hence if the Fed says that interest rate is 5%, it is possible that other loans like home loan, car loan, personal loan, education loan will all be charged an interest rate dependent upon the interest rate determined by Fed or RBI. Typically, house loan may be 2.5% higher than the Feb interest rate, hence it will become 7.5%, car loan may be 4% higher than Feb interest rate, hence it will become 9% and so on. So whenever there is a interest rate change by the regulatory authorities, the bank as well as loan market goes for a complete revamp.

Effectively, when the Fed cuts the interest rates, as it has done recently from 5.25% to 4.75%, it is done to reduce savings and increase expenditure. Since the rate has gone down, it will also reduce the other loan interest rates. Hence buying a house may become cheaper in US, and so will be taking a car loan, education loan, personal loan, etc.

Another effect that happens is that such rate cut also brings down savings and introduces liquidity in the market. Since the rate has gone down, the savings accounts will no longer earn higher interest rates. Hence the risk- free returns will come down. Therefore, investors will now switch their money from bank accounts to stock market investments. Hence, the result of a rate cut is that there is a big switch from safe investments to stocks, which causes huge demand of stocks; therefore the stock markets go up due to a fed rate cut.

Continue to Part II of this article

How Interest rates affect stock prices – II

This is part II of the article, How Interest rates affect stock prices – Part I. Please read the article from part I before continuing with this one

As I’ve mentioned in my previous article Stock Market Collapse, the rate cut by Fed was expected on 18^th September. My feeling was that either Fed will cut rate by 25 basis points (or 0.25%) on 18^th September and by another 25 basis points in next one month, OR it will go for a straight 50 basis point on 18^th September. The second guess came true (I was lucky). Anyways, the predictions are that a further 25 basis point cut may be required and it may happen anytime within a period of coming next 3 months.

Why did Fed cut the rates?

As I’ve explained in my previous article Sub prime mortgage crisis, the different industries are inter-related. The problems identified in the housing loan markets have hampered not only the real estate stocks world wide, but also the different related sectors of Banking, finance, consumer spending and so on. The stock markets in US and around the world took a nose-dive due to the subprime mortgage crisis. Investors lost confidence in stocks and they started taking out the money from stock investments and put it in bank account or interest rate based bonds.

The Fed want to restore the confidence in stock market and also give a positive signal to the investors that the regulatory authorities are not sitting idle. They are taking appropriate action as and when the situation demands. That is the reason that a rate cut by Fed has been welcomed by the investors with a big positive swing in the stock market.

In India, RBI is also expected to go for a rate cut, but not very soon. It may cut the rates sometimes within a period of 4 to 6 months. Well, that’s a long period and situation can change drastically.

So what’s in it for the investors like you and us? If you understand economic factors and finance, you may take a bet in the stock market in the expectation of something to happen. Like I made a guess about the rate cut, it came true (just by luck) an I am now in profit in my ETF investments. However, as explained in my previous article Stock Market Working, anything that is expected is already reflected in the stock prices. So, when you an I make such a guess and invest on that basis, we are doing nothing better than making a bet.

Choice is yours, depending upon you calculations and confidence, you can take a bet :- )

I believe this article should inform you about the relation between interest rates and stock prices. Have nay questions, post in the comments.

You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.