US Treasury Yields - Essay Example

US Treasury Yields US Treasury Yields Carter administration cannot be responsible for inflation that affected the US economy in the 1960s to 1970s. This because inflation can be reflected back to President Johnson era when he increased aggregate expenditure by funding Vietnam War, this reduced employment, and increased inflation. Carter also deregulated government backbones of the economy that led to the reduction in money supply leading to inflation. Market patterns globally affected inflation to grow to a double digit, but this could have been abated if the administration had worked on mitigating it. High-interest rates and inflation during Carter regime discouraged investment with US long-term Treasury yield exceeding 15% and short term T-Bills yielding nearly 20%. Reagan regime restored consumer confidence, through the appointment of Paul Volcker the chair of Federal Reserve Board with his tireless effort and determination of defeating a national economic disaster bore fruits. His fruits were putting the nation into an intentional recession where money supply was tightened, which slowed down the pace of economic growth in the economy, reducing the employment. Inflation was completely abated in the year 1982. After inflation Volcker was devoted to rejuvenating the economy, one of the policies was to reduce the interest rates, this increased money in circulation within the economy that encouraged investment reduced the cost of production and cost of living taming demand-pull and cost pull inflations. Reduction in interest rates encouraged investment with long T-Bills yielding 1% and short-term T-bill yielding 4%. Federal Reserve opinion to increase the interest rates will increase the cost of capital in the economy, and a consumer will be compelled to spend extra coins on the food basket. It will also be translated to investment where due to high-interest rates the profit margins of the lenders will be reduced, moneylenders lend with an objective optimizing revenue. Interest rate burden will be translated to the consumer. It will increase the cost of autos and homes. Interest rates also will affect the consumer retirement benefits high-interest rates will lead to high returns from the cash invested in retirement benefits plan. Consumers will have to spend more to finance autos and homes because of increased cost of borrowing. Present values and Future values of equities will be affected by the interest rates Illustration Interest rates increased from 4% to 6% from the previous year. Calculating the future of a series of cash flows worth $2000 yearly for five years will be Previous yr =FVA(n)=FVIFKA(k,n)*PMT $2000 * 5.4163 =$10832.60 Current year =$2000 * 5.6371=11274.20 The increase in interest rates increases the future value of an annuity invested in a trust fund. It can be attributed to increased return due to increased revenue that translated to the consumer. Increased revenue from the loans will increase investor’s future value. Interest rates increase the growths of annuities. Suppose the project yield $1000 at the beginning of every year. Then the present value of the annuity in 4 years for previous and the current year will be Previous year PV=PMT*PVIFA = $1000 * 3.6299 =36299 Current year 3.4651* 1000 =34651 The increase in interest rates will reduce the present value of an annuity. It is because the discounting factor reduces with increase in interest rates; a value of money reduces with increase in interest rates. As the interest rates, increase the present value of an investment reduces. Net present value calculations It is the difference between present value of cash inflows and outflows of a project. The present value of cash flow reduces with increase in interest rates. Illustration A project has an annual net cash flow of $1400 if the initial outlay of the project is $4200 finding the NPV of the project for the current and previous year we have Previous year Present Value = $1400 * 3.6299 =5081.86. NPV = PV of cash flows – initial capital of the project =5081.86- 4200 =$881.6 Current year Present value = $1400* 3.4651 = 4838.54 NPV = 4838.54-4200 = $638.54 From the illustration, increase in interest rates reduces the Net present value of a project. Interest rates affects the flow of revenue of a projects. Weighted Average Cost of Capital It is the composite cost of capital that a firm is currently using. It is calculated by determining the weighted average cost of each source of capital in the firm’s capital structure This consist of cost debt, equity, and preference shares. The cost of debt is affected by interest rates. The increase in interest rates will hike the cost of debt. The interest rate will spirally increase the cost of capital in the firm this will lead to increased WACC from a previous year to currents year. Corporate Earning Interest rates will increase the cost of production of the firms in the market. It will lead to reductions in earnings by the industries. Some of the firms will increase their debts by borrowing firm to maintain the level of operation in the market. The increase in the cost of operations will be translated to increased prices in the market. High prices in the market will lead to the inflationary spiral that affects the economic stability of the nation. The domestic currency will devalue, exchange rates will increase, oil prices in the domestic market will increase compared to the foreign market leading to a general increase in the cost of living. If the government through trade tariffs consumers does not protect the corporate sector and suppliers will resort to cheap imports compared to domestic products. It will reduce the market share of the corporate sector leading to low revenue this might lead to the collapse in the long run. The collapse of the corporate sector will affect the nations GDP since the corporate sector is the main source of funds for the government. The collapse of the corporate sector will lead to increased unemployment rates affecting the standard of living of the citizens. Low GDP would mean the government would not be able to finance its budget leading to low developments in the economy. References Brealey, R. A. (2012). Principles of corporate finance. Tata McGraw-Hill Education. Bierman Jr, H., & Smidt, S. (2012). The capital budgeting decision: economic analysis of investment projects. Routledge. Copeland, T. E., Weston, J. F., & Shastri, K. (2005). Financial theory and corporate policy. Blinder, A. S., & Watson, M. W. (2013). Presidents and the Economy: A Forensic Investigation. Read More