Introduction
What is the UK’s target inflation rate?
2%
What is the name of the UK Government Bond?
Gilt
True or False: In general, banks are not impacted by interest rate hikes.
False
True or False: A country with consistently low interest rates is likely to experience a depreciation of its currency in the forex market over time.
True
How do higher interest rates help lower inflation?
A higher interest rate means a higher cost of borrowing. This would make people spend less and decrease demand, hence lowering prices.
Are gilts exposed to interest rate risk? Why?
Yes. Interest rate risk is the risk that a change in interest rates will affect the value of a bond. The price of gilts are affected by interest rates.
What sector in the UK is negatively impacted by interest rate hikes?
Energy
Mining
In general, do higher interest rates lead to an appreciation or depreciation of its currency in the forex market?
Appreciation
How did Brexit contribute to UK’s rising inflation?
Higher border costs affected cost of food and shortage of workers led to higher wages.
Would a company want to issue new bonds during times of high interest rates? Why or why not?
No, as it would mean that they have to pay higher coupon payments, which increases their cost of debt.
Explain one way how UK’s interest rate hike has an impact on their equity market.
From a business POV: Cost of borrowing increase gives less incentive for business to grow -> share price falls
Increase in interest rate → Decrease is discount rate → Future earnings are worth less → Investor confidence decreases → Share price falls
Investors gear towards bonds as their coupon payments increase and appear more attractive.
Why do traders closely monitor central bank meetings for potential interest rate changes?
These decisions trigger significant short-term volatility in the forex market.
Why is the UK so greatly affected by the external shocks?
UK is more connected to the global economy. Total trade is roughly 60% of UK's GDP, which is higher than the global average of 56% (Bank of England, 2021).
The UK economy has more foreign assets and liabilities than other major economies.
If you hold a long position in a bond and expect interest rates to rise, would you long or short interest rate futures?
If you hold a long position, you have the asset, and are worried about prices decreasing. Since higher interest rates mean lower bond prices, you would have to protect yourself by SHORTING interest rate futures and fixing the selling price.
Explain the relationship between higher interest rates and company liquidation.
In general, higher interest rates lead to higher corporate insolvencies as their cost of borrowing increases. Banks are exposed to credit losses on their loan portfolio as the risk of default from borrowers rises. Companies that rely on borrowed funds are negatively affected, causing their profits to decrease. Thus resulting in higher liquidation.
Why did GBP depreciate against USD despite an increase in interest rate?
Forex is also affected by macroeconomic events such as the energy crisis.