Today’s Results Plus
Federal Reserve Purchases of Existing Bonds Means Falling Interest Rates
The market shaved DJIA and S&P500 prices by -.33 and -.21 percent as these two averages declined for the first time in six (DJIA) and five(S&P500) sessions. The NASDAQ gained .04 percent for its fifth consecutive close. On the following day, all three indices moved ahead five times and declined on three days.
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Most people recognize the relationship between asset prices and the income earned by the asset. For example, an annual dividend of $200 on a $10,000 savings bank deposit results in a yield of 2 percent. That is, multiplying the $10,000 balance by the .02 dividend rate, results in a payment of $200. Or expressing this relationship in symbols,
Capital X Rate of Interest = Income.
Manipulate this statement by dividing both sides by the Rate of Interest, results in the following restatement
Capital = Income/Rate of Interest.
The fact that U.S. Treasury bonds, as well as most other bonds, pay a fixed annual dollar return for their entire life span means that a direct, but inverse link ties the interest rate to the capital value, or price, of the bond.
Now add three dynamic connections to this network of Capital Value, Income and the Rate of Interest.
One, the only way the Fed can acquire ownership of existing U. S. Treasury bonds is by bidding up the price enough so that current holders of these bonds willingly exchange their bond holdings for Federal Reserve checks,
Two, given the fixed relationship between capital value, interest rates, and the unchanging yearly payment by the U.S. Treasury, interest rates fall as the Fed bids up the price, or capital value, of these bonds,
Three, since all financial capital is interchangeable, the value of all other assets will appreciate along with the rising prices of U.S. Treasury bonds. (Note that each individual asset’s value depends on its risk particular factors and anticipated earnings.)