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Wednesday, 21 December 2011

RBI,Interest Rates,Stock Market

Now a days we are listening much about interest rate hike by RBI to tame inflation. What exactly interest rates are? How these are related to inflation? How  interest rates  effect the stock market? These are the questions arosed in your brain. Am I right? Here I am going to give you some details

What exactly interest rates are?

An interest rate is the rate at which interest is paid by a borrower to lender for the use of money that he borrows from a lender. These interest rates have been set by national governments or Central Banks. For united states it is Federal reserve. England's bank of England and funds rates varied from 0.5% to 15% from 1989 to 2009.For India's RBI(Reserve Bank of India) and the interest rates varied from 3.25% to 14.50% from 2000 to 2010.
Repo Rate: When ever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which our banks borrow rupees from RBI.
When the Repo rate increases borrowing from RBI becomes more expensive.
When the Repo Rate decrease then it is helpful to banks to get money at a cheaper rate.
CRR Rate: Cash Reserve Ratio is the amount of funds that the banks have to keep with RBI.
If RBI decide to increase the percentage of this, the available amount with the banks comes down.
Reverse Repo Rate: Reverse Repo Rate is the rate at which RBI borrows money from banks.
Banks are always happy to lend money to RBI since their money are in safe hands with good interest.
Increase in reverse Repo Rate can cause the banks to transfer more funds to RBI. It can cause the money to be drawn out of the banking system.
SLR (Statutory Liquidity Ratio): SLR is the amount a commercial bank needs to maintain in the form of cash or gold or govt. approved securities(bonds) before providing credit to its customers. SLR is determined and maintained by RBI in order to control the expansion of bank credit.

How interest rates are related to inflation?

Bank interest rates depends on many other factors out of that the major one is inflation.
Whenever you see an increase on inflation there will be an increase of interest rate also.
Inflation may be recognized as of money goes up, the supply of goods goes down, demand for money goes down or demand for goods goes up.
Our Indian government gets involved in it to control the inflation by adjusting the level of money in our economical system. 
Factor like rates of import and export, the production cost of farms, value of dollar, price of oil(crude oil), market movements of other overseas markets cause global liquidity. RBI needs to control this excess liquidity in our economic system. For this RBI increases the Repo Rate which makes Costly credits and thus increases the CRR rate . This kind of measures by RBI can only control the inflation to a certain extent only.

How interest rates effect the stock market?
When RBI increases the funds rates, it does not have an immediate impact on the stock market.
It influence both individual and businesses.
How individual affected?
Individuals are affected through increase to credit card and mortgage interest rates, if they carry a variable interest rate(an interest rate that moves up and down on the changes of an underlying interest rate index)
This has the affect of decreasing the amount of money consumers can spend. After all,people still have to pay the bills, and those bills become more expensive. This means people will spend less discretionary money(The amount of an individuals income that is left for spending , investing or saving after taxes and personal necessities have been paid).
How businesses affected?
Businesses also indirectly affected by an increase in the RBI rates as a result of the actions of individual consumers. Business is also affected direct way as they borrow money from banks to run and expand their operations. Less business spending can slow down the growth of a company, resulting in decreases in profits.
How stock market affected?
RBI funds rate affect the behavior of consumers and businesses as well as the stock market also.

Valuing a company is to take the sum of all the expected future cash flows from that company. If a company is seen as cutting back on its growth spending or is making less profit- either through higher debt expenses or less revenue from consumers then the estimated amount of future cash flows will drop. This will lower the price of the company's stock. If enough companies experience a decline in their stock prices, the whole market or the indexes will go down.
For many investors, a declining market is not desirable out come. to invest.They wanted to see their money to increase in value. When RBI raises funds rates ,newly offered government securities, such as treasury bills and bonds are often viewed as the safest investments. making these investments more desirable.


Commodity Tips-MCX Tips said...

Thanks for the info, it was really helpful. I'll surely visit back again later.

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Burhan said...

Nice info...helps in better understanding now

kedarnath dham said...

nice info :):):)

worldknowledge said...

Thank you very much

Dibesh Sharma said...

good information,thanks

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