What Is Interest Sensitive Stock?
An interest sensitive stock is a stock that is especially influenced by changes in interest rates. Interest sensitive stocks including financial institutions, highly leveraged businesses, and companies that pay high dividends. An interest rate sensitive stock isn't intrinsically worse or better than a stock that is insulated against rate changes. Interest rate sensitivity simply means that the interest rate and interest rate projections become a key part of analyzing the stock as an investment.
Key Takeaways
- An interest sensitive stock is a stock that is especially influenced by changes in interest rates.
- Financial institutions, highly leveraged businesses, and companies that pay high dividends are all examples of interest sensitive stocks.
- Some stocks are especially sensitive to interest rates because of how their sector or business model operates; for example, utilities, REITs, and telecommunications companies often pay high dividends and are often bought for the income they generate for investors.
Understanding Interest Sensitive Stock
In general, stocks tend to be sensitive to changes in interest rates, but some stocks are leveraged to interest rates because of their business model. For most stocks, low rates typically mean lower interest rate expenses on borrowed capital. This can result in higher levels of income as the cost of capital is lower overall. Low interest rates also affect valuations. Analysts use the risk-free rate when they determine the intrinsic value of a stock (with the rates on Treasury securities widely used as the risk-free rate). A lower risk-free rate typically translates into a higher intrinsic value.
Some stocks are especially sensitive to interest rates because of how their sector or business model operates. For example, utilities, REITs, and telecommunications companies often pay high dividends and are often bought for the income they generate for investors. For this reason, these stocks are often referred to as "bond substitutes." Just as bond prices decline when interest rates rise, so do these bond substitutes. When interest rates rise, investors shift out of these sectors on the belief that they can gain a similar level of income without the risk that stocks present.
Homebuilders may also see their share prices fall when interest rates rise. Rising interest rates mean higher mortgage rates, which can translate into fewer home purchases. Companies with large debt levels will also be very rate sensitive because their cost of borrowing is likely to rise. Highly leveraged companies already face an analysis discount depending on their debt-to-income ratio. In a rising interest rate environment, this discount increases.
Banks and financial institutions are, of course, also very sensitive to interest rates. Much of a bank's income comes from its net interest margin—the difference in the rate it pays on its bonds (and its account holders) and the rate it charges on the loans it makes. Because a bank typically borrows on a short-term basis and lends on a long-term basis, rising long-term rates typically boost the net interest margin, bank income, and, therefore, the price of its stock. This is a bit oversimplified as there are many other considerations when evaluating any stock, including banking stocks.
FAQs
Key Takeaways
What does "sensitive" mean in stocks? ›
Sensitivity determines how an investment changes with fluctuations in outside factors. Stocks and bonds are especially sensitive to interest rate changes. The discount rate is an important factor in deriving the theoretical value of stocks.
What is an example of interest rate sensitivity? ›
For example, assume a bond mutual fund holds 100 bonds with an average duration of nine years and an average effective duration of 11 years. If interest rates rise instantaneously by 1.0%, the bond fund is thus expected to lose 11% of its value based on its effective duration.
What is an example of an interest sensitive asset? ›
What Are Interest-Sensitive Assets? Interest sensitive assets are financial products whose features and characteristics or their secondary market price are vulnerable to changes in interest rates. The adjustable-rate mortgage is an example. Banks and their customers both are affected by interest-sensitive assets.
How does interest work in the stock market? ›
When interest rates are rising, both businesses and consumers will cut back on spending. This will cause earnings to fall and stock prices to drop. On the other hand, when interest rates have fallen significantly, consumers and businesses will increase spending, causing stock prices to rise.
What is an example of an interest sensitive stock? ›
Financial institutions, highly leveraged businesses, and companies that pay high dividends are all examples of interest sensitive stocks.
Is very sensitive good or bad? ›
While highly sensitive people are sometimes negatively described as being “too sensitive," it is a personality trait that brings both strengths and challenges.
What bonds are most interest rate sensitive? ›
Long term bonds are most sensitive to interest rate changes.
What is interest-sensitive spending? ›
interest-sensitive consumption
spending that is part of the “C” category of real GDP that is sensitive to interest rates; for example, if you have to take out a loan to buy a big fancy car, you are more likely to do that if interest rates are low.
How do you calculate interest sensitive ratio? ›
Interest rate sensitivity ratio = RSA$/$RSL$.
If interest rates rise (fall), bank NIMs or profit will rise (fall). The reverse happens in the case of a negative dollar gap where RSA$<RSL$.
Interest sensitive liabilities are types of short-term deposits with variable interest rates that a bank holds for customers. Interest sensitive liabilities make up a significant amount of the assets of most banks, encompassing money market certificates, savings accounts, and the Super NOW account.
What are interest sensitive securities? ›
Stocks whose earnings are dependent upon and change with the interest rate, e.g., bank stocks.
What are interest sensitive sectors of the economy? ›
Some sectors of the economy, such as construction and manufacturing, are much more sensitive to changes in the interest rate than other sectors, such as services and retail. To understand why, ask yourself what you think of first when you hear that interest rates have fallen. Buying a house?
Is stock interest considered income? ›
Options, stocks, and bonds can also generate investment income. Whether through regular interest or dividend payments or by selling a security at a higher price than was paid. Any amount received above the original cost of the investment qualifies as investment income.
Do you get paid interest on stocks? ›
Stocks: There are two ways to make money on a stock. The first is through price appreciation, and the second is through dividend payments. When the value of a stock grows over time, an investor has the potential to earn compound interest if those profits are reinvested.
What happens to stocks when interest rises? ›
A higher interest rate environment can present challenges for the economy, which may slow business activity. This could potentially result in lower revenues and earnings for a corporation, which could be reflected in a lower stock price.
Is being called sensitive a good thing? ›
Highly sensitive people may feel pain more strongly, but they also feel joy more fully. The benefits of being sensitive can include deep empathy, high alertness, and exceptional creativity. Being told you are “so sensitive” can be taken as a compliment rather than an insult.
What does it mean if you are price sensitive? ›
Price sensitivity is the degree to which the price of a product affects consumers' purchasing behaviors. Generally speaking, it's how demand changes with the change in the cost of products.
Why is the stock market sensitive? ›
Stock prices tick up and down constantly due to fluctuations in supply and demand. If more people want to buy a stock, its market price will increase. If more people are trying to sell a stock, its price will fall. The relationship between supply and demand is highly sensitive to the news of the moment.
What does sensitive mean negative or positive? ›
Being sensitive is being kind, caring, able to pick up on the feelings of others, and aware of their needs and behaving in a way that helps them feel good. Being sensitive is often a good thing.
