Wednesday, March 21, 2007

Geeky musings

Should the interest rate (cost of borrowing) effect the price of a long lived asset?

This probably has a simple answer, but I'm not sure how to think about it. If the long lived asset is, say, a coupon bond (a stream of predictable cash payouts) then it's pretty clear that the interest rate (cost of borrowing) impacts the price -- as a matter of fact, the interest rate (cost of borrowing) *is* the price of a bond.

One the other hand, I'm not sure if the price of an stock should go up if all of a sudden my bank decides to lower the rate on my margin account. Is a company really more valuable if a bank is more willing to lend me money to buy it? It produces the same goods as before, exists in the same competitive environment, is subject to the same market forces, etc.

My thinking here, of course, relates to the run-up in housing prices, which almost certainly was driven by low interest rates lowering the monthly payment on people's mortgages, enabling them to take on bigger loans. But they are living in the same house.


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