The Importance of Interest Rates

We may not always realize it, but interest rates play an important role in our every day lives and can greatly affect our buying power. Consequently, the overall trend of interest rates can have a major effect on your investments, thus, as an investor it is important to pay close attention to these trends. Major shifts in direction, be they up or down, should cause you to review present investments as well as point towards potential opportunities.

Keeping abreast of general interest rate trends doesn't require much time, in fact, it takes mere minutes a week. Key rates, which are important to the investor, are published daily in the major newspapers as well as on some financial websites. They are as follows.

  • The Treasury Bill (T-Bill) is the benchmark for short-term interest rates. Many of the short-term interest rates on the market such as auto loans and floating rate mortgages are tied to, and mirror, the T-Bill. For instance, if the T-Bill begins to slide, one can expect the return on a money market account to slide as well.
  • The Bank Rate is the interest rate at which the Bank of Canada lends money to the chartered banks. The movement of this rate can be an early indicator of future interest rate trends.

Regular review of these key indicators can result in confusion and mixed signals on the investor's part. However, once a consistent trend emerges, these guidelines can assist you in assessing the impact of interest rates on your investments and also help direct future investment decisions. An important factor to consider during this assessment is that there is an inverse relationship between interest rates and bond prices. As interest rates go up, bond prices go down. Why? Because the bond's fixed coupon is less attractive than market rates.

If a bond's price has dropped below its face value because prevailing interest rates for that particular maturity are above its coupon, the bond is said to be trading at a discount. Conversely, if rates have declined below the coupon rate, the bond is trading at a premium above its stated value.

Stocks also react to interest rate changes. In general, if the yields on virtually risk-free short term Treasuries are attractive, investors may become reluctant to put their money into stocks, where the short-term risks could be higher.

Certain stocks such as bank and utilities are particularly sensitive to interest rate changes. Banks, in particular, make much of their profit on the difference between what it costs them to borrow money and the rate at which they lend it (also called the spread).

With the help of an Investment Advisor, an investor can better assess the degree of exposure that a portfolio has to fluctuating interest rates. Contact a CIBC Wood Gundy Investment Advisor today and find out how you can potentially reduce risk and help ensure healthy returns.

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