RacingGreen07 From , joined Dec 1969, posts, RR: Posted (7 years 11 months 1 week 3 days 17 hours ago) and read 2422 times:
I'm doing some business coursework....and need some help please!
I have made a fictutious business and it requires a source of finance. I have opted for a bank loan. However should I go fixed or variable? If I go for variable then I am able to take advantage of any low interest rates in the future. However if I go fixed then I am not able to take advantages of lower interest rates and vice versa!
Its really difficult because I can't quite grasp whats going to happen to interest rates...
What are the predictions? And what signs (in today's market) indicates interest rates will rise or go lower in the UK? What do you guys think I should do with regards to choosing a type of loan?
People are paid lots of money to make these decisions. I'm not too familiar with UK markets, but if I was to borrow cash now in the US, I would be more likely to get a fixed rate, with interest rates so low. If I get a variable rate loan now and the economy makes a rebound, you're going to get stuck with higher rates. Of course you'd be hard pressed to have people extend you credit now in the US.
It's all about expected interest rates through the maturity of your loan.
Newark777 From United States of America, joined Dec 2004, 9348 posts, RR: 27
Reply 3, posted (7 years 11 months 1 week 3 days 16 hours ago) and read 2390 times:
Quoting RacingGreen07 (Reply 2): Currently in the U.K I think the base rate is 5.25% in your opinion is this low? In the late nineties (according to the Bank Of England) the interest rate was around 7.0%!
The problem is I don't know if the BoE will increase or decrease the rates. Thats why I'm having trouble deciding....
If you can take a look at the current yield curve for UK treasury securities, that would give you a good start on expected trends in rates. It's basically years to maturity on the x axis vs. current interest rate on the y. The shortest maturity bills will have the rate closest to the risk free rate, and under standard conditions the curve will rise slightly ("upward sloping yield curve"). An overly steep yield curve could be a sign of expected increasing yields in the future, and a flatter or inverted curve could be a sign of expected decreasing yields. There are many factors at play, though, and this is just one of them.
A 5% rate can be high or low depending on the situation, but past information is not important, though, as I alluded to before. It is expected future performance that matters.
I am checking that out right now. You mean Term Structure of Interest Rates or is that different?
I'm also trying to find articles which predict what kind of interest rate changes can/will occur. So far, I have found quotes (which will go into my coursework) from major banks and investors predicting a further slash in interest rates......They just don't say WHY! which is really annoying!
The yield curve is the visual representation of the term structure. So yes, they're basically synonymous.
Quoting RacingGreen07 (Reply 4): So far, I have found quotes (which will go into my coursework) from major banks and investors predicting a further slash in interest rates......They just don't say WHY! which is really annoying!
Interest rate cuts occur when there is an expected slowdown in the economy. Lower interest rates make it easier to obtain credit, and therefore cash, which is then spent, boosting the economy. Once the economy starts recovering, interest rates are raised to keep inflation under control.
And keep in mind the difference between interest rates set by the government (here in the US, Federal Funds Rate, Discount Rate, etc.) and the interest rates set by the market (which is what the yield curve illustrates).
Farnborough24 From United Kingdom, joined Nov 2007, 167 posts, RR: 0
Reply 6, posted (7 years 11 months 1 week 3 days 14 hours ago) and read 2365 times:
Essentially, if you're reading papers and are seeing things like 'consumer spending on the up', 'record profits in retail sector', 'British people owe more than ever before on credit cards', it means people are spending a lot. To counteract this, interest rates rise to encourage people to save. Higher interest rates=more money if you save, and hence an incentive to. The banks need people saving money, as this saved money is what they then pass on to other people wanting to borrow, and the government need people saving as they need healthy banks. Look at the chaos the Northern Rock debacle caused.
Consequently, if consumer spending slows too much, interest rates need to be lowered to encourage people to spend more. It becomes cheaper for people to borrow money and less beneficial for them to save it if rates fall, and hence consumer spending rises. In the US, where the sub-prime mortgage crisis has caused an economic slowdown, interest rates have been slashed to get people to spend more, because they're not spending enough to keep businesses alive.
Hope the above helps. It's been simplified a fair amount, but they're the basics. As to what your business should do looking at the current economic climate, it depends what it's doing/where the money is coming from. I can't make that decision for you!
Comorin From United States of America, joined May 2005, 4909 posts, RR: 14
Reply 7, posted (7 years 11 months 1 week 2 days 20 hours ago) and read 2348 times:
You are talking about Interest Rate Risk.
What percent of your costs are interest related? Unless your business is financially oriented, and you don't want to mismatch funding, I wouldn't worry about it too much. A good question to ask is what is the change in profit if my interest rate shifts by 1%, and if that is significant.
At today's low cost of borrowing, I would go with the fixed rate, otherwise you are exposed to interest rate risk. You will be entering into a term loan, so make sure the term of the loan matches your needs. Having said that, most business loans today are floating rate.