Unit 24

Interest rates and bond prices

The change in interest rates has important implications for the stockmarket prices of bonds, which pay a fixed rate of interest: fixed-interest securities, of which the traditional gilt-edged securities issued by the government are the most familiar though companies also issue fixed-interest bonds. It works like this.

Gilt-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 gilt-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 gilt-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 his outlay. The "light" 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 his investment. So in the stockmarket the price of the gilt-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 - боргове зобов'язання

to put up the money - вкладати гроші

to redeem - погашати (цінні папери)

irredeemable stock - коштовні папери, що непогашаються

undated stock - цінний папір без указівки дати погашення

to hold on (to smth) - зберігати що-небудь, триматися за що-небудь

vise versa – навпаки

Assignments

1. Suggest the Ukrainian equivalents

pay a fixed rate of interest: fixed-interest securities; IOU; become entitled to receive the interest; the original investor.

2. Replace the parts in italics by synonyms

has important implications; undertakes to pay; people who put up the money; agrees to redeem the stock; become entitled to receive the interest

3. Fill in the gaps with the words and expressions from the text

1. The change in __ has important implications for the stockmarket prices of bonds, which __.

2. Of fixed-interest securities the traditional __ issued by __ are the most familiar though companies also issue __.

3. When the government needs to borrow money, it issues __ as a form of __ and undertakes to pay so much a year in interest to the people who __ and who get the IOU __.

4. When the government __ securities, it normally agrees __ the stock at some date in the future.

5. The original investors can sell their __ to other __, who then become __ from the government.

6. The investor __ to pay $100 for the right to receive __, because this represents an 11% __ on his __.

7. If __ rates rise, the __ investor sees __ fall.

8. __, the value of his investment __ if interest rates had fallen.

9. If interest rates on securities __, bond prices or prices for securities __, and __.

4. Find in the text English equivalents for the following

боргове зобов’язання; непогасимі цінні папери (без вказання дати погашення); навпаки, напроти (2 варіанти)

5. Explain in English

a promissory note; IOU; fixed-interest securities; irredeemable (undated) stock

6. Answer the questions

1. What does the government do when it needs to borrow money?

2. What are the implications of the change in interest rates for the stockmarket prices of bonds? Explain how it works.

7. Translate into English using all the active possible

1. Держава, випускаючи в лихоліття облігації як боргові зобов'язання, коли йому необхідно зайняти гроші в населення, гарантує зворотну виплату всієї зайнятої суми плюс накопичений відсоток.

2. Ви не маєте права на допомогу по безробіттю, якщо ви ніколи не працювали.

3. Уряд виділив близько 500000 доларів, щоб врятувати популярний футбольний клуб.

4. Більш висока процентна ставка невигідна для інвесторів, що уже вклали свій капітал в акції з фіксованим дивідендом, тому що вона означає для них великі втрати.