I am not sure I understand how increasing market rates increase equity and lower the value of debt. can someone explain this to me ?
increasing market rates should not affect book values because interest rate on the books is fixed for corporate bonds market value changes however. when you issue debt you sell bonds. when interest rates increase, bonds price decreases -> your debt decreases -> your equity increases
Thanks Maratikus ? But why do bond prices decrease ? Is it because people get more value for their money in other areas as interest rate increase ?
i understand that when interest rates increase, bond prices decrease, but how does that have anything to do with your debt to decrease it? book value stays constant. if you’re talking about issuing new debt in the future, yes you will get less back but debt will still increase no?
Never mind I get it. A decrease in rates causes the PV of the bond to increase which increases the market value of the bond and thus causes a decrease in equity. However we do calculate interest expense with the market rate at issuance of the bond so how does this impact our equity if market rate changes. This will only affect us if wee retire the debt early .
you got it ucla_engineer. when rates change, MV changes because PV of future cash flows changes. however, interest rate changes don’t affect the book value and, therefore, don’t affect equity - i think that’s all you should know about this subject for Level I exam. In Level II balance sheet items are adjusted to market values, then equity value changes but you don’t need to worry about it until next year.