I was reading The Intelligent Investor, I have a question on this quote.

[beau]

This quote is particularly from Chapter 11: Security Analysis for the Lay Investor.

"A given schedule of expected earnings, or dividends would have a smaller present value if we assume a higher than if we assume a lower interest structure.*"

Then at the bottom of the page, the commentary of Jason Zweig explains this quote further:

"When interest rates are high, the amount of money you need to set aside today to reach a given value in the future is lower - since those high interest rates will enable it to grow at a more rapid rate. Thus a rise in interest rates today makes a future steam of earnings or dividends less valuable - since the alternative of investing in bonds has become relatively more attractive."

From what I understand, basically if you use a higher discount rate to discount future earnings/dividends, the present value will be lower. But this explanation really confuses me. Why has investing in bonds become relatively more attractive? Is it because when banks interest rates rise, bonds become cheaper?

[smallcaps]

Its comparing investment in equities vs investment in bonds. Equities earnings yield vs bond yield.

[beau]

Its comparing investment in equities vs investment in bonds. Equities earnings yield vs bond yield.

Hi smallcaps,

thank you for the reply, it always seems to be you answering my newbie questions. Do you care to explain it a bit further? The whole interest rate thing really is hard for me to grasp.

[smallcaps]

When interest rates go up, bond prices go down in order to give a higher bond yield. Or else might as well put the $$ in the bank account.

When deciding whether to put money in equity or bonds, pe ratios/earnings yield and also bond yields are taken into account.

[Tiggerbee]

This quote is particularly from Chapter 11: Security Analysis for the Lay Investor.

"A given schedule of expected earnings, or dividends would have a smaller present value if we assume a higher than if we assume a lower interest structure.*"

Then at the bottom of the page, the commentary of Jason Zweig explains this quote further:

"When interest rates are high, the amount of money you need to set aside today to reach a given value in the future is lower - since those high interest rates will enable it to grow at a more rapid rate. Thus a rise in interest rates today makes a future steam of earnings or dividends less valuable - since the alternative of investing in bonds has become relatively more attractive."

From what I understand, basically if you use a higher discount rate to discount future earnings/dividends, the present value will be lower. But this explanation really confuses me. Why has investing in bonds become relatively more attractive? Is it because when banks interest rates rise, bonds become cheaper?

Typically, a bond investor should only invest in bonds when interest rates are high because the coupon rate will also be high. And when interest rates had peaked and starts to decline, bond prices will rise.

[jjlim84]

interest rates rises, future stocks dividend present value decreases, but bond pays you based on coupon rate (interest rate), so makes bond more attractive lor, isn't it

[beau]

Thanks guys I get it now

[corydorus]

interest rates rises, future stocks dividend present value decreases, but bond pays you based on coupon rate (interest rate), so makes bond more attractive lor, isn't it

I believe this applies only to new bond in the market being more attractive after interest rate rise. Bonds you bought earlier can only enjoy agreed rates. So I assume we may see volatility in this bond prices.

[jjlim84]

interest rates rises, future stocks dividend present value decreases, but bond pays you based on coupon rate (interest rate), so makes bond more attractive lor, isn't it

I believe this applies only to new bond in the market being more attractive after interest rate rise. Bonds you bought earlier can only enjoy agreed rates. So I assume we may see volatility in this bond prices.

Yup..when your old bond has a lower coupon rate after interest rate rises, it will be harder to sell, that's the interest rate risk of bonds

[beau]

interest rates rises, future stocks dividend present value decreases, but bond pays you based on coupon rate (interest rate), so makes bond more attractive lor, isn't it

I believe this applies only to new bond in the market being more attractive after interest rate rise. Bonds you bought earlier can only enjoy agreed rates. So I assume we may see volatility in this bond prices.

Yup..when your old bond has a lower coupon rate after interest rate rises, it will be harder to sell, that's the interest rate risk of bonds

Which is exactly why interest rates and bond prices are inversely related right? Because when interest rates rise, bond yields become less attractive, hence bond prices have to go down to compensate for this.