TOPIC: Market interest rates and its implications on
PREPARED BY: ABDUL QADIR
The topic of my assignment is the market interest rates and its implication on
investment decisions. Every person needs money to live a better life. Now there
are different modes of gaining money like the person can start a business or to
invest it. Everyone today appreciates the need to save whether for a house, for
Children’s education, a wedding, or for use after retirement. All these goals
can be realized through excellent financial planning. An intelligent plan
Entails investing your money in an appropriate combination of assets with
potential to generate the income needed to achieve your goals. If we invest
wisely, we can maximize the return on our investments.
There are many investment avenues available, but a wise investor does not
invest on impulse, a hot tip or follow the herd. An investor should
discriminate between information, casting away irrelevant and illogical
pieces of information, and checking for opportunities and facts before
making an intelligent choice of investments.
Now when we talk about investment, there are also many types of investments.
Now the investment in stock exchage or the investment in any private business.
One thing is to be remembered that where we invest the affect of or we can say
that the risk of interest rate will be there. Now greater the risk the higher will be
the return. But this is doesnot mean that to get a high return we will have to take
risk, but infact financial planning will be needed. Because there are many ways
through which we can minimize the risk one is the diversification.
The investment in stock exchange The aim of investing in stocks and shares is to
buy at low and sell at high. Knowing when is however, the problem.
Many investors attempt to time the market: they try to figure out when the market
is going up and buy before it does and then anticipate when it is going to crash and
sell before that. Usually you try to buy when the upswing has begun and sell as the
downswing starts. However, such accuracy is extremely difficult to achieve.
The term "investment" is used differently in economics and in finance. Economists
refer to a real investment (such as a machine or a house), while financial
economists refer to a financial asset, such as money that is put into a bank or the
market, which may then be used to buy a real asset.
In finance, investment is equal to cost of capital, like buying securities or other
monetary or paper (financial) assets in the money market or capital markets, or in
fairly liquid real assets, such as gold, real estate or collectibles. Valuation is the
method for assessing whether a potential investment is worth its price. Return on
investment will follow the risk return spectrum.
Types of financial investments include shares. Other equity investment and bonds
These financial assets are then expected to provide income or positive future cash
flows, and may increase or decrease in value giving the investor capital gains or
Investments are usually made through intermediaries. Such as bank, mutual funds,
pension funds, insurance companies, though their legal and procedural detail
differ, an intermediary usually made investment using money from many
individuals, each of whome receive a claim over the intermediary.
Interest is the price paid for the use of savings over a given period of time. Interest
is a fee paid on borrowed capital. Assets lent include money, consumer goods
through hire purchase. The fee is compensation to the lender for foregoing other
useful investment that could have been made with the loaned money. Instead of
the lender using the assets directly, they are advanced to the borrower. The
borrower then enjoys the benefit of the use of the assets ahead of the effort
required to obtain them, while the lender enjoys the benefit of the fee paid by the
borrower for the privilege.
The amount lent, or the value of the assets lent, is called the principal. This
principal value is held by the borrower on credit. Interest is therefore the price of
credit, not the price of money as it is commonly - and mistakenly - believed to be.
The percentage of the principal that is paid as a fee (the interest), over a certain
period of time, is called the interest rate.
Market interest rates
Who sets the interest rates? There are markets for investments which include the
money market, bond market, as well as retail financial institutions like banks,
which set interest rates. Each specific debt takes into account the following factors
in determining its interest rate:
Since the lender is deferring his consumption, he will at a bare minimum, want to
recover enough to pay the increased cost of goods due to inflation. Because future
inflation is unknown, there are three tactics.
Charge X% interest 'plus inflation'. Many governments issue 'real-return' or
'inflation indexed' bonds. The principal amount and the interest payments
are continually increased by the rate of inflations.
Decide on the 'expected' inflation rate. This still leaves both parties exposed
to the risk of 'unexpected' inflation.
Allow the interest rate to be periodically changed. While a 'fixed interest
rate' remains the same throughout the life of the debt, 'variable' or 'floating'
rates can be reset. There are derivative products that allow for hedging and swaps
between the two.
There is always the risk the borrower will become bankrupt, abscond or otherwise
default on the loan. The risk premium attempts to measure the integrity of the
borrower, the risk of his enterprise succeeding and the security of any collateral
pledged. For example, loans to developing countries have higher risk premiums
than those to the developed government due to the difference in creditworthiness.
An operating line of credit to a business will have a higher rate than a mortgage.
Creditworthiness of businesses is measured by bond rating services and
individual's credit scores by credit bureaus. The risks of an individual debt may
have a large standard deviation of possibilities. The lender may want to cover his
maximum risk. But lenders with portfolios of debt can lower the risk premium to
cover just the most probable outcome.
Charging interest equal only to inflation will leave the lender with the same
purchasing power, but he would prefer his own consumption NOW rather than
later. There will be an interest premium of the delay. The discussion at time value
of money. He may not want to consume, but instead would invest in another
product. The possible return he could realize in competing investments will
determine what interest he charges.
Length of time:
Time has two effects.
Shorter terms have less risk of default and inflation because the near future
is easier to predict. Broadly speaking, if interest rates increase, then
investment decreases due to the higher cost of borrowing (all else being
Interest rates are generally determined by the market, but government intervention
- usually by a central bank- may strongly influence short-term interest rates, and is
used as the main tool of monetary policy. The central bank offers to buy or sell
money at the desired rate and, due to their control of certain tools (such as, in
many countries, the ability to print money) they are able to influence overall
market interest rates.
Investment can change rapidly to changes in interest rates, affecting national
Understanding the relationship between interest rates and investments
Interest rate and investment both have a strong relationship with each other.
Different economic factors also affect the interest rate. Both short- and long-term
interest rates are affected by economic factors such as inflation, the strength of the
rupees and the pace of economic growth.
For example, strong economic growth due to more investment can lead to
inflation. If the state bank becomes concerned about inflation, it may attempt to
cool the economy by raising the funds rate’
On the other hand, if the economy seems to be slowing, then it may lower the
funds rate to stimulate economic growth, Economic factors also affect long-term
interest rates. It should be noted that short- and long-term interest rates don't
necessarily move in tandem. So the sbp may raise the rate to keep inflation in
check or lower it to stimulate the economy.
Affect of interest rate on bond prices
Interest rates and bond prices have an inverse relationship. As illustrated below,
when interest rates rise, bond prices generally fall. Conversely, when interest rates
decline, bond prices tend to rise.
Interest Rates and Bond Prices
Have an Inverse Relationship
When rates go up, newly issued bonds come to market with higher yields than
existing bonds. The newly issued bonds are more attractive than comparable
existing bonds with lower yields. In order to sell their existing bonds, investors
will likely reduce their prices to make them equally attractive.
Generally speaking, the prices of longer-term bonds are more sensitive than
shorter-term bonds to changing interest rates. Similarly, fixed income funds with
longer average maturities tend to be more sensitive to interest rate changes than
funds with shorter average maturities.
Interest rate and business
Generally changes in interest rates have an effect on consumer confidence. Only
when people are reasonably confident about their own financial position will they
be willing and able to enter into large scale purchases. Higher interest rates have a
negative effect on consumer confidence - lower rates have the reverse effect,
although again there are time lags to consider.
Firms take interest rates into account when deciding whether or not they go ahead
with new capital investment spending. A fall in interest rates should help to
increase business confidence and raise the level of planned fixed investment
Some discussion about the risk
Whenever we invest in any security or in bond or any where the risk is always
there. The interest risk is the danger that shifting market interest rates can reduce
the net income. Bond prices are affected by interest rate changes. Bond prices, and
thus a bond fund's share price, generally move in the opposite direction of interest
rates. As the prices of bonds in a fund adjust to a rise in interest rates, the fund's
share price may decline
Talking about the investment in stock market i.e. in shares
So far I have talked that how the companies invest by using the different portfolios
of securities. Definitely the risk factor is minimized but there are some investors,
which individually invest in the stock market with the help of stock brooker. If the
investor can afford to take some risk and have the ability to endure the market’s
ups and downs, equity investments may grant him good returns. The investor
invest in stocks and shares with the aim to buy at low and sell at high. Knowing
when is however, the problem. Many investors attempt to time the market: they try
to figure out when the market is going up and buy before it does and then
anticipate when it is going to crash and sell before that. Usually we try to buy
when the upswing has begun and sell as the downswing starts. However, such
accuracy is extremely difficult to achieve.
The market interest rate definitely affect the investment decisions of the investor
in the stock market. When the interest rate rise the share prices fall and when the
interest rate fall the share price rises. So it is very important for an individual
investor to consider these things.
Investors can choose to make their own dealing decisions or take advice from a
professional. Buying and selling shares and tracking their performance can be time
consuming but it is rewarding for those who have the time to manage their own
investments. Some investors deal with stockbrokers directly while others prefer to
use the services of professional managers who have discretionary powers to
manage the investment portfolio to minimize the market interest rate risk.
Study of the organization:
Pakistan Kuwait investment (Private) Company Limited
Introduction of the company
Pakistan Kuwait Investment Company (Private) Limited is a leading Financial
Institution engaged in investment and development banking activities in Pakistan.
Pak Kuwait is a 50:50 joint venture between the Governments of Pakistan and
Kuwait and was established in 1979 with a paid-up capital of Rs. 250 million
contributed equally by the two joint venture partners and over the years paid-up
capital has increased manifold and currently stands at Rs. 6 billion.
Pak Kuwait is the highest capitalized Development Financial Institution operating
in the country with a net worth in excess of Rs. 11 billion. It is a progressive
organization that provides attractive return on investment to its shareholders. This
is also evident by its impressive history of dividend payouts, which amounted to
Rs. 9.232 billion since the time of its inception. The company’s strength lies in its
strong business relationships within Pakistan and Gulf region.
The driving force behind Pak Kuwait’s success has been its organizational
structure, professional excellence of management, sincerity of its leadership and
keen participation of the Board of Directors in the company matters. The
Government of Pakistan and the Government of Kuwait has also provided its full
support and cooperation from the inception to-date, which is the main source of
strength for the management to operate the company professionally on sound
Investment function of the company
Investment Banking Function is evolving into a complete financial solution
provider specializing in development of Greenfield projects, Merger and
Acquisitions, Debt Syndications and Private Equity Placements. The Investment
Banking team at PKIC is focused, goal oriented and committed to its objectives.
Each Single transaction is treated individually and tailored made in accordance
with the requirements of the client. Their teamwork, passion and innovative
approach towards transaction management distinguish them from the rest of the
Capital Markets Department works with the objective of increasing the
participation of Pak Kuwait in the securities markets of the country and
thereby contributing to profitability of the company.
Management of resources assigned to capital markets. Achievement of tax
efficient sources of income, i.e. Capital Gains and Dividends. Reduction
of risk through diversification
Development of fee based sources of income through investment advisory
business. Encouraging stock market activities by extending cooperation in
Initial Offerings, Pre Initial Public Offerings, Underwriting and
sponsoring Mutual Funds
Establishment of Open End and Close End Fund
Earning Financial income and Variable income
Corporate Finance Department is responsible for establishing and
maintaining relationships with clients for funded and advisory business.
The activities undertaken by the department are:
Soliciting, developing, and maintaining relationships
Selling credit/non-credit based products and services
Maximizing profitability to meet the financial targets/goals
Implementing the company's income budget
Ensuring adherence/achievement of revenue targets
Keeping a very close watch on the dynamics of market risk
Liaison with the Risk Management Department in screening of
target markets and customers
Risk management function of the company
The objective of the risk management department is to Establishment and
adherence to stringent Risk Management guidelines and operating
parameters is the key behind Pak Kuwait's sterling achievements over the
years. Pak Kuwait's Management has a clear appreciation of the Credit
Risk and interest rate Risk functions and has engineered requisite operating
parameters to manage the distinct risks within acceptable limits.
All potential business proposals ( Credit Memorandums ) are carefully
screened by the Senior Management Review Committee (SMRC) and only
those which meet Pak Kuwait's strict internal credit guidelines/criteria are
put forward for approval to the Executive Committee or the Board.
Furthermore, the portfolio is strategically diversified with exposure in
various industries i.e. Fertilizer, Pharmaceutical, Textile, Cement, Energy
Market Risks and interest rate risk arising from business activities are
monitored and managed by the Asset & Liability Committee (ALCO).
ALCO provides strategic direction in relation to Balance Sheet
Management and the approach followed is to offset undesirable risk by
combining the strength of Pak Kuwait's balance sheet with business unit