Interest Rates and Equity Investors

Introduction

Investments and interest rates go hand in hand in business since they determine the expected benefits from a certain venture. The cost of capital thus clearly defines what interest rates are as well as their availability. Equity investors make more money when the interest rates are high since this is conducive for businesses. Other than this, reduced operation costs and a high production favour investments in that high profits are guaranteed. Interest rates are thus an investment determinant in that they influence the economic climate, cost of loans and the discounted value (Piana, 2001, pp. 1).

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Equity investors are companies that are interested in initiating businesses or growing existing ones to the highest level as long as the market is favourable. To kick off their business, equity investors look at working with sectors that are attractive, have a well laid down business plan, have a competitive advantage and also those that have a proven track record. With these features, they will be able to formulate strategies that will take the business to greater levels through the transaction of clean businesses (PWCIL, 2003, pp. 3). This paper seeks to critically discuss the factors that would cause equity investors in developed countries where low interest rates prevail to seek alternative investments in other emerging market economies where interest rates are reasonably high.

Literature review

The mention of interest rates brings the question of price to the picture since they actually refer to the cost. Just like any other commodity in the market, interest rates are influenced by demand and supply of money. However, in this case, borrowing and lending best describes these transactions in the money market. If businesses, government units and households require money for expenditures, the demand rises and this is followed by heavy borrowing. On the other hand, the supply of the required money will depend on how much money is available in the financial market.

This money comes from the savings made by governments, investors and individuals. This interaction thus determines how high or low the interest rates will be. Other factors that affect interest rates include expectations, federal reserve as well as inflation. In times of inflation, the purchasing power is reduced and this leads to high interest rates. The same is reflected when the federal reserves influences the lending and borrowing trends. The expectations that people have on the market may also lower or increase the interest rates as it influences their lending and borrowing (Leisenring, 1980, pp. 1-9).

Interest rates determine the economic climate for equity investors in that the lower they are the lesser returns they get on their investments. This is one vital reason why they seek to venture into new markets where interest rates are higher as this will be reflected in the profits they will make. Low interest rates result from a poor state of the economy in a country which leads to a decrease in revenue. This discrepancy is reflected in the investment markets where the purchasing power takes a nose dive. In addition, the higher the unemployment rate in a country the lower the interest rates will be.

This directly affects the financial markets and the final result is low interest rates on investments. When the interest rates are high, the financial markets pick in that they are able to give out more loans to equity investors. Their deposits also become higher since the economic atmosphere is conducive. For financial survival, equity investors have to look for new markets since a depression in interest rates affects their earnings on an hourly basis and this can lead them to close shop (Connell, 2010, pp. 2-3).

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Equity investors have many reasons why they favour higher interest rates to lower interest rates since they aid their ventures. Higher interest rates increase spending for retirees and people who have invested in bonds. This group of people make up a good market for equity investors who are hired to help people in investment projects. Higher interest rates favour equity investors in that new markets have tendencies of offering cheap labour since the cost of production is low. This is occasioned by the fact that the prices of fuel and foods decline as there is a lot of money flowing.

In addition, higher interest rates offer a higher reward for risks and this adds value for the equity investors. This tends to work negatively in low interest rates and this is more reason why they favour new markets with higher interest rates. Strong currencies are associated with high interest rates and this makes it favourable for equity investors. Countries with a higher interest rate attract more investments and this reflects on the cost of imports which become significantly low. This works well for equity investors who end up spending less as they set up businesses and this translates into higher profits for them. Higher interest rates lower the cost of bonds and this attracts more investors (Duff, 1999).

Analysis and discussion

Highlighting the benefits of higher interests triggers the question of why lower interest rates, as appealing as they seem may work negatively for equity investors. The main reason why equity investors abandon their home markets to seek new ones is that lower interest rates come with inflation. When people have a higher borrowing power due to the low rates charged on their loans, they tend to become impulsive spenders. This causes inflation in the long run and the cost of production is bound to increase in the sense that electricity and fuel prices will escalate.

This leads to high levels of unemployment as businesses cut down on the number of their employees to enable them meet the rising costs of running the business. In addition, equity investors target savers and lower interest rates dents their savings. For instance, pensioners live on the interest they gain from their savings and low interest rates will reflect badly on their spending behaviour. The value of their savings declines and continues to get worse as inflation increases.

Another demerit of lower interest rates is the impact they have on imports. The cost of importing goods becomes higher and this makes it difficult to invest in any business. This makes it difficult for equity investors to transact businesses in the new markets since they will only manage to make huge losses. This also works negatively on people’s spending since the local merchandise will become expensive as they will not be facing any competition from outside.

People will therefore have less money to spend and this keeps equity investors out of employment. Lower interest rates also attract recession and the recovery becomes slow. The main reason is that financial institution will not be in a lending mood. They could have the low rates but there will be no money to be lent out. The people also loose confidence in the economy and this leads to less spending since the future seems uncertain and this does not favour the equity investors either (Pettinger, 2008, pp. 1-2).

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Higher interest rates have their shortcomings which include slowing down the economy. This is occasioned by the fact that financial institutions lend less and this impacts negatively on businesses which lay aside their expansion plans. This could derail the equity investors since people opt to spend less as there are limited finances. High interest rates also impact negatively on people in that they repay their loans at a higher rate and this discourages them from applying for them. In addition, home values tend to decline despite the higher rates as people’s spending becomes limited. High interest rates which remain so for long could lead to a recession which brings with it job cuts thus impacting negatively on people’s spending habits. However, high interest rates could be an opening for people to make more money due to low costs of production and this is what works for equity investors (Amadeo, 2006, pp. 2-8).

Between 2002 and 2007, equity investors flourished due to the fact that the interest rates were on a high. The default rates were low and these conditions made it favourable for the investors. There was a notable increase in the managed assets as individual transactions soared to billions. Following the great recession that hit many countries of the world in 2007, equity investors were worst hit since the spending behaviour reduced significantly as businesses closed and millions of people were rendered jobless (Stowell, 2010, pp. 360).

As a result, many businesses initiated by the equity investors turned out as great disappointments for many people who had decided to invest in them. Their equity values dropped so low due to the depressed economy that most of them closed down. This greatly affected the business of equity investors since the years 2008 and 2009 saw many sectors becoming more cautious on when and how to invest. Most of them shied away from such ventures and this was a great disadvantage to the investors who had previously enjoyed the boom. However, mid 2009 gave a new lease of life to the equity investors since many countries in the diaspora had started recovering from the global recession and thus sought to get back to business. This created a firm ground for the investors to do what they do best; create firm and sound investments for the future and make money while at it (pp. 361).

In other cases, equity investors aim to own parts of foreign companies by purchasing shares in a process known as equity buyout. They make their purchase so low to enable them reap profits in future in the investment they have made. However, equity buyouts are risky since if a company went down, the equity investors end up losing their investment. Other than this, equity investors also act as angel investors in companies that are fighting with bankruptcy.

They loan them the necessary funding on condition that they will own part of the company through shareholding. These companies are referred to as distressed assets and equity investors carry out their duty of restoring these companies to profitability. There are many such opportunities in developing countries and this is another reason why the investors capitalize on this avenue to reach the new markets (pp. 364).

Conclusion

There are many factors that would cause equity investors in developed countries where low interest rates prevail to seek alternative investments in other emerging market economies where interest rates are reasonably high as evidenced by this paper. From this research, it is evident that high interest rates favour equity investors in that the currency becomes stronger making imports cheaper. This promotes businesses in that the cost of production reduces as processed goods become more affordable.

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In addition, high interest rates favour savings as they encourage people to save more. Equity investors benefit highly from this since financial institutions have a lot of money from the savings made and this encourages lending at low interest rates. Higher interest rates curb inflation and this works at stabilizing the markets. Low interest rates on the contrary lead to inflation which leads to an increase in production costs. This, as we have seen in this study reflects negatively on the equity investors who work at maximizing profits.

Inflation also makes business loose confidence in the economy of the day and this discourages their expansion as they fear collapse. People who may be willing to spend tend to hold back as they are uncertain of the future. The financial institutions lending mood lowers since they are afraid that they may loose their money in the recession which depresses businesses. High interest rates favour equity investors in that more employment opportunities are created and this increases production.

References

Amadeo, K., 2006. A primer on the role of interest rates in the economy. US Economy, 2(3), pp. 2-8.

Connell, S., 2010. How low interest rates affect your investments. Financial Planning. The Connell Group, 2(1), pp. 1-4.

Duff, V., 1999. The advantages of high interest rates. Business and Finance, 4(1), pp. 3-6.

Leisenring, C., 1980. High interest rates: Causes and effects. Congressional research service. The Library Congress, 80(4), pp.1-9.

Pettinger, T., 2008. How much should interest rates fall? Economics Journal, 6(2), pp.1-2.

Piana, V., 2001. Investment. Economics Web Institute, 8(2), pp. 1-3.

PWCIL., 2003. Equity Raising. Preparing your business for equity raising. Pricewaterhouse Coopers Network, 5(1), pp.3.

Stowell, D., 2010. An introduction to investment banks, hedge funds and private equity: The New Paradigm. UK: Elsevier Inc.

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