Question

what do you consider to be the most important factor in determining the valuation of both bonds and equities? (Note that valuation is either the market price of the bond, or the current stock price.) In your post explain both the reason you believe this is the more important factor and how that factor varies with different market conditions.

Answer 1

Answer: I feel that the most important factor that determines the valuation of both bonds and equity is the inflation rate. The inflation rates play an equal role in determining the value of both bonds and equity. When the interests’ rates rise they result in the fall of both bond and equity prices. The inflation has an eroding effect on the purchasing power of the people and reduces the disposable income in their hands. This negatively impacts the economic growth and demand inside the economy. The less demand results in a lower valuation of both bonds and equity. In the bonds the inflation erodes the purchasing power of the investments which means that the maturity value of the bond will worth less as compared to the past because of the increase in inflation. Also as the inflation rises the central banks increase the interest rates for reducing consumption and hence the other instruments like bank deposit offer better interest rates. This reduces the valuation of bonds. Similarly in equity markets the rise in inflation causes the equity prices to fall because of negative sentiments of the investors and the reduction in demand in the economy because the central banks increase the interest rates. When inflation becomes less than the reverse cycle takes place resulting in increase in both equity and bond prices.