Week 4 Discussion: Interest Rate, Stock Valuation, Risk and Returns

The Role of Macroeconomic Factors in Influencing Interest Rates

Changes in interest rates based on the changes in the market interests constitute the risk in any industry. These changes can be accompanied and caused by various macroeconomic factors, starting from inflation to governmental intervention (Peiro, 2016).

Government:

When the government expenditure surpasses government revenue, it goes on to borrow money. In this case of fiscal deficit, the government borrows a large amount of money which in turn influences the demand for money, thus causing high-interest rates.

Inflation:

Inflation refers to the increasing of prices which means that the purchasing value of money has gone down. The prices of all commodities are determined and controlled by inflation. On the other hands, interest rates are the prices of money borrowing. Thus, high inflation causes high-interest rates.

Foreign Exchange Rates:

With the emergence of globalization, countries have become associated with the global economy in a manner that was not possible in earlier times. Thus, the interest rate in one country is related to the interest rates in other countries in an integral way. A central bank can increase its interest rates to attract investors from other countries, by influencing exchange rates.             

Aviation Industry and Macroeconomic Factors:

The aviation industry is one of the biggest industries that have accompanied and made the global economy a reality. However, like any other industry, it is also subjected to the changes in the global economy and its impacts on interest rates in the industry.

Geopolitical threats can be impacting global relations across countries which would then affect the global economy causing changes in the global GDP. Global threats such as the USA-China dispute and the UK leaving the European Union have caused necessary measures that have majorly impacted the aviation industry. For instance, it was predicted that the USA-China trade dispute could cause a 2-3% decline in global GDP (The State of the Aviation Industry, 2020).   

Airlines are majorly impacted by rising interest rates in the industry. It has been suggested that even a small change in the interest rates can affect the borrowing rates for airlines in a major way. Because of this, airlines are increasingly resorting to fixed-rate borrowing.            

Stock Valuation:

Stock valuation refers to the process which helps to predict the future market prices so that an investor can invest in some stock with low risks (Sharafoddin & Emsia, 2016). It analyses the market condition of stock and helps to determine the future market value. There are multiple ways to value stocks, each of which has its own strengths and weaknesses. Whereas some techniques may look for its own financial condition to determine, some would suggest comparing it with other competitors in the industry.    

Airlines stocks are subject to the overall state of the economy in the sense that the aviation industry is a crucial element in the global economy. The good condition of the economy results in good revenues for the aviation industry and vice versa. In the same way, when the people of the country have lower discretionary incomes, the aviation industry is set to face downfall due to lower demand of airlines, thus affecting the stock (Fardnia et al., 2020).   

Financing a Company:

Whenever a company needs to borrow money for financing the company, there are two popular ways: bonds and stocks, each of which has its own strengths and weaknesses. Bond refers to a loan except that it is not from a bank. In issuing bonds, an investor lends money to a company. In exchange, the company must pay some periodic interest payments until the bond reaches its maturity date when the firm needs to repay the investor. On the other hand, issuing shares of stock to investors in exchange for money may be more attractive than bonds in the sense that the money does not need to be repaid. However, in this case, the ownership of the firm gets divided among stock shareowners.

Risk and Return in Financial Decision-making:

There are two forms of risk associated with the financial decision-making of a company regarding stock valuation. Diversifiable risk regards the events which are related to the company whose stocks are being purchased, whereas market risk is affected by macroeconomic events. On the other hand, return depicts the profitability of the investment. Thus, the analysis of the risk and return of stock represent an effective way to judge the profitability of an investment. 

References:

Fardnia, P., Kaspereit, T., Walker, T., & Xu, S. (2020). Financial performance and safety in the aviation industry. International Journal of Managerial Finance.

Peiro, A. (2016). Stock prices and macroeconomic factors: Some European evidence. International Review of Economics & Finance, 41, 287-294.

Sharafoddin, S., & Emsia, E. (2016). The effect of stock valuation on the company’s management. Procedia Economics and Finance, 36, 128-136.

The State of the Aviation Industry. KPMG. (2020). Retrieved 6 December 2020, from https://home.kpmg/ie/en/home/insights/2019/01/aviation-industry-leaders-report-2019-state-of-aviation-industry.html.