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Aswath Damodaran NEGATIVEINTERESTRATES: IMPOSSIBLE,IRRATIONALOR JUSTUNUSUAL? March2016 AswathDamodaran 1 NegativeInterestRateCurrencies:Central BankandMarketRates 2 Aswath Damodaran 2 10-yearGovernmentBondRates:By Currency(March9,2016) 3 Aswath Damodaran 3 InterestRates101:AnIntrinsicInterest Rate 4 Aswath Damodaran 4 InterestRates101:AMarketSetRate 5 Aswath Damodaran 5 IntrinsicversusMarket-setInterestRates– ConvergenceandDivergence 6 Aswath Damodaran 6 TheCentralBank’sInterestRatePlays 7 Aswath Damodaran 7 NegativeInterestRates 8 ¨ ¨ Theconventionalviewofnominalinterestratesisthat theycannotbenegative,sinceyouhavetheoptionto holdcash(ratherthansaveitatnegativerates). Thisisbasedonthepresumptionthatholdingandusing cashiscostlessandthatmaynotholdfortworeasons: ¤ ¤ ¨ Storingcashmayrequiresecurity (anditscosts). Usingcashforsome transactionsmaybeexpensive andperhaps infeasible. Ifyouintroducecoststoholdingandusingcash,nominal interestratescanbenegative,albeitwithalowerbound, sinceatsomeinterestrate,itwillbelessexpensiveto holdcash. Aswath Damodaran 8 TheEffectofInterestRatesonStockand BondPrices 9 Aswath Damodaran 9 InterestRatesandtheRealEconomy 10 Aswath Damodaran 10 TheHubristicBanker 11 Aswath Damodaran 11 TheRealWorldBanker 12 Aswath Damodaran 12 ERPandRiskFreeRates 13 Aswath Damodaran 13 Dealingwithnegativeinterestrates 14 1. Switchcurrencies:Ifthecurrencythatyourcompany reportsfinancialsinhasanegativeinterestrate,switch toadifferentcurrency. Caveat:Youcanrun,butyoucannothide. 2. Normalizeriskfreerates:Replacethecurrent(negative) interestratewithanormalriskfreerate,obtainedfrom eitherhistoryorfundamentals. Caveat:Normalization isintheeyeofthebeholder. 3. Staywiththenegativeriskfreerate:Usethenegative riskfreeratebutmakesurethatyourother assumptions(nominalgrowth,riskpremiums)are consistentwithadeflationary,no-growtheconomy withhighriskpremiums. Aswath Damodaran 14 ImplicationsandConsequences 15 1. 2. 3. 4. Badnews:Negativeinterestratesareincompatible withahealthy andgrowingeconomy. Insanity,ImpotenceorIrrelevance? Centralbankshavelowered ratesoverandoverinthelastsixyearsandhavenotbeen ableto nudgeeconomies outoftheircomas.Buttheykeep doingit..The veryfactthattheykeep goingbacktothislever isasignalof impotence onthepartofpolicymakers. Unintendedconsequences:Investorswhodesire (andneed)fixed income fromtheirinvestments increasingly havetolook further andfurtherawayfromtheirpreferred domains forthatfixed income. Thepotentialforscamsandinvestment painisimmense. Digitalcurrencies:Totheextentthatcentralbanksmake it unattractivetosavetheircurrencies, theyarecedinggroundto digitalcurrencies. Aswath Damodaran 15