Understanding Bond Yields And The Stock Market Essay | Relationship Between Interest Rates And Yield Curve.

The impact of the great recession on the stock market

1. After the shock of great recession, it has been perceived that the same has been contributed towards the rise in the stock market. In United States, the bond yield has been significantly declined after the 1970. As compared to the late 20s, the yield rate has been found to be significantly lower from the year 2009 to 2020. If there are low interest rates, it will tend to make the stock market price high. On the other hand, if the economy is facing economic expansion, the stock price and the bond price will move in opposite direction since they are competing the capital. After the recession, the bond curve and stock price are seen to be moving towards proper direction.  

Bond yield can depend on various factors such as inflation, default probabilities, duration as well as economic growth. The bond yield is a fixed amount being paid therefore if there is any decrease in the inflation rate, it will increase the inflation rate and yield of the bond. In this situation, the bond will be more attractive to the stakeholders and as a result the price of bond increases thereby causing low nominal yields. Lower expectations of growth and inflation denotes that the bond yield are low and if tere are high growth, it will lead to high interest rates as well as bond yields . If there are any sale of stock in the period of economic expansion, it will reuslt in the increase in bond price and lower yield since the money will move into the bond market. If there is any optimism in the economy, investors can transfer their funds into stock market since it benefit from the economic growth. In the determination of the bond yields and the stock price relation with the bond yield, interest rate plays a key role therefore it is essenial to understand the role of interest in yield curve and stock market. In an economy, if the interest rate as well as the inflationary pressure is low, it will result in the bond yield and stock price movement to flow towards the same direction. In the process of stimulating the economy, central bank can play a key role since central banks can improve the economic condition with the help of monetary policy. if there is any upward movement of bond price and stock price, it will result in the moderate economic growth.

Yield curve discusses the bond yield for a point of time and the relation between the interest rate and the time of maturity is shown with the help of the yield curve. 

The expectations of investors about the future interest rates are reflected using the yield curve.  Short term bond is usually influenced by the market participants and the long term bond yield are usually affected by different macroeconomic factors such as business cycle, budget deficits or inflation. The shape of yield curve shows the current market situation and risks associated with the economic condition.  

Bond yield factors and their impact

Normal yield curve starts with low yield rate and increases with the maturity of the bond. If the bond has long term duration, it will lead to greater risk and higher maturity date will cause the curve to become flat. Yield curve which is inverted is geneally abnormal and only occurs when the short term maturity bonds are higher than the long maturity bonds. In the situation, there is higher demand short term investment to compensate for uncertain situation. The shape of yield curve changes with accordance to the macroeconomic situation and has influenced stock market to signfiicant extent. Without the understanding of yield curve, it is not possible for investors to make investment deecisions in stocks. If the yield curve denotes that the economy will perceive a slowdown, investors can understand the same accordingly and will consider moving their stocks from a underperforming company to a company that performs well in slow economic situation. Furher, if the yield curve is showing that the interest rate is increasing over the years, the investors will invest their stocks into cyclical companies to generate better return from their stocks.

Investors who invest into the preferred stocks can also understand the stock market situation with the help of the yield curve. If the yield curve becomes steep, it will result towads high growth and high inflation rate therefore investors will invest in short term bonds instead of long term bonds. The flattening yield curve shows that the economy as well as the stock market will face high inflation and recession. Therefore it can be noted that the investors can understand the current stock market situation with the help of the yield curve.  

The bond yield curve can be used to understand the future interest rate of an bond and thereby can allow in understanding whether specific economy is contracting or expanding due to other economic variables. Futher, it can be noted that inflation can come from the strong economic growth and bond yields can offset the affect of inflation. Investors always try to comprehend the spread between 3 month rate and 10 year note. The short end reflects that the interest rate is set by the central bank and the long end is set by market conditions. Therefore, it is evident that the short end is primary determinant of the curve and the curve can steepen depending on the decisions of central bank. Hence, it can be noted that yield curve can reflect the economic situation in which central bank stimulates the economy. Before understanding the stock market situation and understand the spread between the 10 year yield and short term yield investors always assess the bond yield. Inversion of the yield curve can occur when stock market declines and the same indicates that the yield curve is not leading indicator.

On a concluding note, the above discussion shows that the yield curve is not always the indicator of the economic situation however the bond yield rate and the stock market is interrelated. If the yield curve is invereted, it does not always show that the stock market is going down in recent times. However, short term inverted yield curve can indicate that the economy is vulnerable and hence investors will not invest into the stock market if the vulnerability in the economy persists.

The relationship between bond yields and stock prices

2.  

Current ratio can be noted as a liquidity measure of a company that will allow them to evaluate the ability of a firm to pay off its short term liabilities within one year. Stakeholders and other external users can understand the how a firm is utilising its current assets to pay off its debts and other payables.  From the above analysis, it is evident that the current ratio of Singapore Airlines is estimated at 1.35 while in the current ratio of EasyJet is estimated at 1.05 indicating that Singapore Airlines is more capable of paying off its obligations and liabilities than EasyJet.

Quick ratio is a measure of a firms short term liquidity situation therefore it is used to understand whether a firm can be able to pay for its short term obligations. The above analysis denotes that the quick ratio of Singapore Airlines is situated at 1.30 whilein the quick ratio of EasyJet is estimated at 1.05. higher quick ratio of Singapore Airlines is denoting that the company has higher amount of quick assets than the current liabilities and with the increase in quick ratio, the firm will have more liquid position so it will be able to convert its cash any time if necessary.

Debt equity ratio shows the contribution of investors and stakeholders in the capital employed of a company. Higher number of debt to equity ratio indicates that the firm poses significant amount of risk for the stakeholders and lenders therefore indicates that the company is not efficiently using its debt. From the above, the debt to equity ratio of EasyJet is found to be significantly higher (0.27) than Singapore Airlines (0.07) denoting that EasyJet will have to face signficant amount of risk as compared to Singapore Airlines.

The efficiency of a company in the payment of the interest outstanding on debt can be noted as an interest coverage ratio. This measure allows in understanding the overall financial health of the company in meeting its interest related obligations from its operating earnings. The above analysis indicates that Singapore Airlines have significantly higher (21.81) amount of interest coverage ratio than EasyJet (7.45) which shows that Singapore Airlines have enough profits to service the debts.

Operating profit margin evaluates the profitability of a company after paying off its cost of production. Return on asset is denoted as a financial ratio that evaluates the amount of profitability of a company in relation to its total amount of assets [8]. This metric can be used to understand the efficiency of a firm in generating its profit from the use of its assets. The return on asset of Singapore Airlines is denoted as 2.14% while the ROA of EasyJet is estimated as 9.02%. The higher amount of ROA indicates that Singapore Airlines is more efficiency in the management of its balance sheets in profit generation.

Net profit margin is a neasure that is used to measure the percentage of profit from the revenue of a firm. Evaluating net profit margin of a company is essential to measure overall profitability of a company. From the above, it can be noted that the net profit margin of Singapore Airlines is estimated at 2.92% while for EasyJet, the net profit margin is estimated at 9.35%. This indicates that EasyJet can efficiently control the costs related to its products and services at a price which will be profitable for the company. Higher net profit margin of Easyjet shows that the company has efficient management.

The role of interest rates in yield curve and stock market

Asset turnover ratio is a measure used to evaluate the efficiency of a firm in generating revenue from the efficient use of its assets. Higher amount of asset turnover ratio of EasyJet is showing that the firm is very efficiently using its assets to produce sales for the firm  than Singapore Airlines.

Based on the above section of the analysis, it can be noted that Singapore can decide to ground off its flights during the pandemic situation on the basis on different factors. The operating profit margin of the firm is higher than its peers therefore the firm can be able to utlise its assets efficiently during the timeframe. Further, it can be also noted that the firm has lower amount of debt to equity ratio than its competitors which will allow the firm to manage the debt related issues during the timeframe of the pandemic. Further, Singapore Airlines will have enough amount to service the debts during the timeframe and thereefore Singapore Airlines can decide to ground off its flights during the time of the pandemic situation.

3. The theory which explains and resolves issues related to the relationship between principal and the agent can be noted as the agency theory. The relation between shareholders and their agents are understood with the help of the agency theory.  In the airlines industry, there can be various stakeholders associated with the agency theory including owners, operators, passengers, employees as well as cargo services. In broad term, the agency is the relation between two parties in which the agent reprensents principals in daily transactions.

In British Airways, the government plays the role of principal while the airlines company plays the role of an agent. Without the supervision of the principal, it is impossible for the agent to implement actions associated with the principals. The decision making authority in the airlines industry lines with the government (principal) while the agent follows the decisions made by the government. However, it is essential to denote that the interest of the principal  and the agent does not always follows the same line which can be reffered as the principal agent problem. As per the definition, the agent uses the resources of the principal and agent takes only some decisions related to the day to day operations of the airlines industry. However, in most cases, the risks or losses are borne by the principals therefore agents will not have to incur any losses or risks. On the behalf of the principals and the agents, there can be various problems associated with the agency which can further impact on the reasoning behind the agency theory. Agency theory is used to evaluate disputes in two key areas: difference in risk aversion as well as difference in goals. For instance, a manager or executive in the airlines industry can seek for the short term profitability and in the context, they might expand the market into the new high airlines industry however same can pose serious affect to the shareholders therefore the long term growth and share price of the airlines industry can get significantly affected.

Understanding the yield curve

Further, the incompatible level of risk tolerance can be also massively affected the government and the agent (airlines company). It is essential to reduce agency loss with the context of agency theory in order to understnad the alighment of interests that could be achieved with relavant stakeholders of the airlines company.

There can be various proponents of agency theory that can aid in resolving disputres accross the principals as well as the agent. Agency loss can be denoted as the amount of loss that an agency has occured due to the contrary to the interest of the principal. In order to reduce loss occuring within the airlines comoany, the principal can offer incentives to managers which will allow them to maximize profitability. The relation between the principals and agents can be understood with the help of the agency theory. However, in improving the short term profits, a company can endanger their long term growth and the same can affect their budget planning as well as the performance goals. 

In airlines industry, there can be various costs associated with the macro structures. This structure also includes private, mixed and public structure. There has been various changes in the ownerships of airlines company which has been found to impact the performance of airlines industry to significant extent. However, most of the UK airlines manitanins SOE strucure which allows the airlines company to stimulate economic growth and allow the economy to improve other areas such as trade, tourism aned employment. With that being said, it is noteworthy to mention that researchers have argued that private airlines have performed better than the public airlines and therefore any changes in the ownership structure of airport companies can significantly affect the overall performance of airport companies. In the airlines industry, the agency cost can come from two forms- transperancy and political involvements. Researchers have found that the agency cost is very mch lined with the government owned airlines (prinicipal agent relationship) than the private owned airlines. Furthermore, it has ben also found that the financial capabilities of the airlines can be greatly affected by the government interventions and the same can create agency problems. Agency propblem in the airlines industry can massively pressurise the voting capabilities of the stakeholders and therefore stakeholders can be massively affected by the government interventions. Further, the decision making of agents are also found to be affected by the political influence which is present in the state owned airports.

Understanding political objectives are key in the section since it allows in deeper comprehension of the agency cost associated with the two structures. In the fundamental state owned airlines, the primary objective has always been to fulfil government objectives as well as meet social objectives. However, this can affect the profit making potential of a business thereby affecting its overall stakeholder relations negatively. Further, the state owned airlines has the potential to balance the social as well as political interest desite of the the fact that political involvement in the case is inevitable. Therefore, the relation amongst accountability as well as transperancy is very interrelated when the agecy cost is strong. Agency cost are costs that can be used to prevent any types of interest. In the airlines industry, there is always a lack of correlation between the structural differences as well as agency cost that can affect the overall agency relation in the industry. The level of agency cost can get significantly affected if the agency cost is not measured effectively. If there are any potential conflicts, disagreements or disutes, it can create agency problem and it is essential to prevent principal agent conflicts in order to improve the environment of the airlines industry. As per the agency theory lens, there are generally two key assumptions

• Invidual people are very egoistics and they seem to act according to their self interest
• Agents can access to information and are affected by the decision making capacity.

The importance of yield curve for investment decisions

Therefore, to resolve the other mentioned agency issues, it is essential to compensate the agents and address the disputes between principals and agents. Further, it there are any type of risk aversion, it is also needed to be measured and evaluated.

4.  

 Towards the expenses incurred by Dave for the purchase of the downtown house in Dubai, Dave will have to pay £679.61.

 For the 18th birthday of his son, Ayman will have £57,086.78.

5. Capital structure is noted as the mixture of debt and equity used by a firm to finance its growth and operations. Equity capital can arise from different ownership shares of the firm can the same can allow in future cash flow for the firm. On the other hand, debt can come from different sources of bond issuance or loans whilein the equity can come from different types of stocks (common stock and preffered stocks) and retained earnings. Capital structure is the mixture of the long term debt, short term debts as well as common and preffered stock of a company. In the analysis of capital structure, the short term debt and long term debt of a company is evaluated and considered. The debt to equity ratio of a firm is used to evaluate the riskyness of a firms borrowing practice. If a company is more financed by the debt, it will have a aggressive capital structure as well as it will have more risks for its investors. With the help of debt, a company can generated money from the capital markets. Businesses will not have to pay off any ownership in the debt financing. On the other hand, the equity can allow the investors to take a stake of a company.

When a firm increases its financial leverage, the return on equity of a firm significantly increases thereby increasing the stock volatility. Increase in the level of financial leverage can also increase risks for a firm however it can also increase return for the firm. For instance, if the leverage of Microsoft company increases, it will significantly impact the stock price of the firm and will increase risk for the firm. On the other hand, increasing leverage can affect the cost structure of the firm and the firm will have difficult time in managing its short term revenue fluctuations. Further, the bottom line of the company will be greatly affected due to the same and the firm will have hard time in managing its flexibility.

On the other hand, if the financial leverage of a firm is lower, it will going to afffect the sales revenue of the firm significantly and the firm will experience more evident changes in profit with the changes of revenue of the firm. Increased fixed expenses contribute to higher operational leverage, and increased operating leverage means more vulnerability to revenue fluctuations. Operating leverage that is much more sensitive is deemed riskier since it suggests that existing profit margins will be less safe in the future. While this is more risky, it does imply that each sale generated after the break-even point contributes more to profit. In a cost structure with such a significant level of operational leverage, there are lower variable costs, because variable costs always eat into additional productivity—though they also lower losses from poor sales.

Using yield curve to evaluate the stock market situation

The risk profile of a firm can be understood with the help of its degree of operating leverage. Investors can understand how vulnerable the firm is in respect to sharp economic changes and swings. Leverage, on the other hand can assist a firm to finance their assets as well as invest in business operations which can ultimately improve shareholder value for the firm. With the increase in leverage of the company, the firm will have increase in return on equity due to the increased level of stock volatility. Increase in leverage can also assist the firm in financing different sources which is essential for the firm to achieve its earnings. However, despite of providing higher amount of returns, higher degree of financial leverage shows riskier position of a firm which can further affect the future sales and proftabilty of a company negatively. Further, it is also evident that higher amount of financial leverage can improve the growth and development of a firm. Leveraged growth for a company has always been feasible, but most organisations have struggled to manage the close but flexible partnerships necessary to share assets until recently. Asset sharing nearly usually necessitates the smooth execution of operations that span many firms. At least in the way they've been characterised, leveraged growth connections go well beyond traditional joint ventures and other sorts of alliances. To use a computer word, most conventional alliances are "tightly connected." Their scope and objectives are well specified in legal papers and operational agreements that have been methodically drafted. Negotiating them normally takes a long time, and once they're up and running, they're difficult to change. As a result, businesses often form a small number of strategic alliances or joint ventures, making it difficult to adjust them to changing market conditions. Leveraged growth connections, on the other hand, usually feature more looser asset owner couplings.

The utilisation of operating leverage has been found to increase profitability and affect the risk exposure of a company. On the basis of how a firm should finance its operations, leverage can negative affect the short term expenses of a company and can result in more exposure to risk. Therefore, firms need to capitalise the oppportunity by leveraging its short term position with its debts. However, if a firm takes on too much debt, it can directly affect on the liquidity and solvency position therefore the firm will not be able to meet its payment requirements as well as short term and long term cash flow related goals. Further, as the firm continues to incur more debts for the business, the equity valuation of the firm will be greatly affected and will be reduced thereby affecting it to incur more debt within the busiess. For the long term prospect, a business can benefit from the higher amount of leverage however a company must have to weather its added cost of debt to the benefits of the financial leverage. 

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