Question

In: Finance

Many of the central banks of the leading world economies have for years been actively working...

Many of the central banks of the leading world economies have for years been actively working for very low interest rates.  What impact has this had on asset prices?  Please explain.  Use the CAPM to provide a frame of reference for your discussion

Solutions

Expert Solution

The environment of low interest Rates are best for the appreciation of asset prices. Low interest Rates provides with an environment for easier environment for high Money supply.

A low interest rate regime is seen as a stimulating factor to drive demand in the economy. When central banks want to increase the money supply in the economy, they adopt a liberal monetary policy which is focused at Improvement in money supply through liberalisation of interest rates.

When the interest rates are cut, the savings of people increases significantly and when they invest their savings , that helps in appreciation of asset prices at an increasing pace.

Through capital asset pricing model, it is seen that investors demand a high rate of return for high level of risk. When the interest rates are low, the risk of the investors are low and expectations are not that high either so investors demand a lower market rate of interest to compensate for the risk. So In the environment of low interest Rates,the CAPM expectations are low because the risk premium of investors are low.


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