Currency Wars: “Beggar Thy Neighbor” Policy
February 12, 2025
While the system of debit and credit is the foundation for maintaining balance and accuracy, it can often feel overwhelming for beginners and even for clerical staff who handle day-to-day bookkeeping. The Golden Rules of Accounting are designed to simplify these concepts into actionable principles that anyone can use. These rules break down the most […]
In the previous article, we discussed the concept of sports tourism. We have seen how sports tourism has a wide definition and includes many different types of travel activities. We can say that there is evidence to support the claim that the presence of sports leagues and franchises does lead to an increase in tourism […]
The valuation of a sports franchise is a very difficult task. This is because a lot of the rules that are applicable while valuing other businesses are not relevant when it comes to valuing sports franchises. One such example is the widespread usage of the price-to-revenue ratio in deriving the valuation of a franchise. In […]
Investment bankers are intermediaries in the capital-raising process. This means that most of the time, the deals which go through are not pitched by either party but by the intermediaries i.e., investment bankers. Since sourcing a deal is the first step that an investment bank can take towards the generation of revenue, investment banks have […]
Start-ups are private entities. It is true that start-ups thrive because of the resourcefulness and innovation of the people behind the start-up. However, the empirical data suggests something equally interesting. It is important to note that many successful start-ups tend to be located in the same geographic areas. This is because many times, governments in […]
In the past month, the Dow Jones Industrial Average had seen a spectacular fall. The market had crashed more than a thousand points. This crash happened on the speculation that the Federal Reserve i.e. the central bank of America is planning to raise interest rates. The mere mention of the possibility of an interest rate hike caused the market to have a panic attack. This obviously raises the question about why is it that markets are affected so drastically by decisions made by the central banks. In this article, we will have a closer look at the relation between the stock market and the central bank.
Graham Dodd is considered to be the father of stock valuation. In 1934, he wrote a book explaining how the modern theory of valuation has departed from the traditional principles. He believes that the old approach was more dependent upon the past performance. This means that the dividends that the firm has paid in the past, the absence of any debt and the strong track record of the management were considered major factors in stock valuation.
However, this has changed now since the entire theory has become more future-oriented. This means that a firms value is now based on the amount of cash flow it can provide in the future. This means that even a firm has not paid a single penny in dividend till date, its valuation can be justified by saying the value will be received in the future.
However, the basic theory of finance says that a dollar today is more valuable than a dollar tomorrow. Hence, the future cash flow dollars of a company need to be discounted at the present rate to arrive at a valuation. The discount rate being used therefore has a huge bearing on the final stock value. Since the discount rate is derived from the interest rate, interest rates become extremely crucial. It is for this reason that central banks decision to hike or lower the rates can have a massive impact on the stock market. It is for this reason that it can be said that 2018 will have a general negative trend. The Fed is planning about four consecutive interest rate hikes and this may lead to some form of a correction in the stock market.
There are two reasons why changes in the interest rates affect the valuation of stocks:
In simpler words, a lower interest rate creates a false image making a firm look more profitable than it actually is.
The increase in the interest rates leads to a precipitous fall in the stock market. This is mainly because of the following reasons:
In short, the entire economy is misled by the central banks when they drop interest rates. For a short while, they create an artificial boom which is followed by an even larger bust. The problem with this is that people do not want to suffer the consequences and start afresh. As a result, they ask central banks to lower the rates even further. This creates another temporary boom which negates the losses made from the earlier bust. However, this boom is also temporary at best and is likely to lead to another bust. Hence, it is the low-interest rates set by the central bank that creates business cycles. This is exactly what happens after every bust. For instance, consider the government policies of zero interest rate after the 2008 subprime crisis.
Your email address will not be published. Required fields are marked *