Question

Please identify the specific asset classes with the most exposure risk to any type of distortion that might be created by US central bank policy decision-making. What might trigger a change in sentiment across investors in this space? Please explain.

Answer 1

Financial exposure refers to the risk inherent in an investment, indicating the amount of money an investor stands to lose. A Central bank enact monetary policy to keep inflation, unemployment, and economic growth stable and positive. When the economy overheats central banks raise interest rates and take other contractionary measures to slow things down - this can discourage investment and depress asset prices. Understanding how monetary policy can influence various asset class prices can position investors to take advantage of changes in rates or other measures taken by central banks.

2 assest classes with most exposure.

• Risk Exposure on Bonds = Higher short-term interest rates are a big negative for bonds, as investor demand for higher yields sends their prices lower. Bonds suffered one of their worst bear markets in 1994, as the Federal Reserve raised its key federal funds rate from 3% at the beginning of the year to 5.5% by year-end
• Risk Exposure on Equity = Equities underperform during tight monetary policy periods, as higher interest rates restrict risk appetite and make it relatively expensive to buy securities on margin. However, there is typically a substantial lag between the time when a central bank commences tightening monetary policy and when equities peak.