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 arc 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 earns $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 "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 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.

Vocabulary notes

a promissory note	долговое обязательство
to put up the money	вкладывать деньги
to redeem	погашать (ценные бумаги)
irredeemable stock	непогашаемые ценные бумаги
undated stock	ценные бумаги без указания даты погашения

2. Answer the questions to the text.

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.

3. Suggest the Russian equivalents for the following word-combinations and make up sentences with them.

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

4. Find in the text English equivalents for the following.

Долговое обязательство; непогашаемые ценные бумаги (без указания даты погашения); наоборот, напротив (2 варианта).

5. 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.

6. Give explanations in English.

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

7. Translate into English using all the active possible.

1. Государство, выпуская в тяжелые времена облигации в качестве долговых обязательств, когда ему необходимо занять деньги у населения, гарантирует обратную выплату всей занятой суммы плюс накопленный процент.

2. Вы не имеете права на пособие по безработице, если вы никогда не работали.

3. Правительство выделило около 500000 долларов, чтобы спасти популярный футбольный клуб.

4. Более высокая процентная ставка невыгодна для инвесторов, уже вложивших свой капитал в акции с фиксированным дивидендом, так как она означает для них большие потери.