Interest Rate Question BlackRock
Hello, I had a superday last week with BlackRock Multi Asset Strategies and was asked what was the effect/relationship of rising interest rates on both stocks and bonds. For bonds, it was fairly straight forward (rising rates decreases bond prices). I had prepared a lot and from my readings on the internet (i.e. Investopedia) i knew that rising interest rates may cause a downturn in the stock market because companies need to pay more to borrow money which decreases profits and investments. Also, customers have less money to borrow and thus less money to spend. Furthermore, rising rates right now in the US would cause an increase in bond yields which would increase the US dollar value and harm exports. I said this answer but the interviewer kept questioning nonstop??? He asked if I knew the CAPM and about forwards and about stocks already pricing in the effect of rates? I was so confused but decided to stick with my answer. Any opinions?? What should I have said??
Bump??? Im sure its a fairly straightforward topic
I'd greatly appreciate any thoughts whatsoever
It's hard to know what exactly the interviewer was trying to get at since I was not there. The answers you gave are all correct. But based on him mentioning CAPM, forwards, and pricing in the effects, I think the following is what he was trying to get at. So CAPM states that the expected return on a security=risk free rate+Beta of that security(equity risk premium). When rates go up, the risk free rate will go up, but so will the Beta. Why? Because the Beta in CAPM is the levered beta, so it reflects both business and financing risks. Since higher rates means higher borrowing costs, the Beta will be higher. Thus, it follows that the expected return on a security should go up when rates also go up. If CAPM is indeed correct, then we should see stock prices climb higher after a rate increase, and that should be reflected in the price of forwards. So although your answers are correct, the interviewer was digging deeper to see your understanding of capital markets theory and expectations.
Thanks a lot for the thoughtful response. I would interpret it differently. In respect to CAPM, if the risk free rate has rise, then borrowing costs would rise and a firm's WACC would rise. Therefore, calculating the firm's value utilizing a FCFF the valuation of the firm should fall, as the interest payments would rise.
Thus, that is why asset managers have largely expected low equity returns going forward. Conversely, when the fed was lowering rates, the stock market ballooned.
Please let me know if you think my analysis holds any water.
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