Influence of the benchmark interest rate on bond prices

The benchmark interest rate and inflation are two monetary policy tools that will affect the Indonesian economy in many ways. This includes influencing investor decisions in choosing bond investment tools.

In this article, the authors discuss the theoretical impact of changes in monetary policy instruments on bonds and how they are calculated. The hope is that you can set the right investment tools amid the threat of rising interest rates by the Fed and Indonesian banks in the future.

Before discussing the impact on bond prices. First, let’s understand what the benchmark interest rate is.

What is the reference interest rate?

The benchmark interest rate is the target interest rate set by the central bank.

This target must be used as a reference or benchmark for savings and borrowing rates by banks and other financial institutions in countries where central banks operate.

in Indonesia This reference interest rate is known as BI rate or BI 7-day repurchase rate (reverse) (BI7DRR)While in the US the term Federal Funds Rate

Why is the reference interest rate important?

To answer the question of why interest rates matter. Let’s take a simple example. For example, if BI rates the BI rate at 3.75%, the bank-supplied loan interest rate is 10.75%. However, if the BI rate increases to 4.5%, the loan interest rate also increases to 11.5%.

This means that if the BI rate increases, the amount payable by the borrower from the bank increases as well.

Usually, the increase in monetary policy instruments is due to the improving economy of the country and, therefore, high inflation. The increase in interest rates is intended to reduce the volatility of inflation.

On the other hand, if the country is in a recession Bank Indonesia will cut the BI interest rate so that people can borrow from banks at low cost. to get the economy back up and running again

The effect of interest rates on bonds

Rudiyanto, director of Panin Asset Management, in his book Obligasi Pahami, Enjoy, said that in theory Interest rates have a negative correlation with bond prices. This means that if the BI rate increases, the bond price will decrease and vice versa.

This is because:

1. Investors turn to stocks. Along with economic development marked by rising inflationInvestors are more willing to buy instruments that carry more risk than bonds, i.e. stocks.
   Stocks are riskier than bonds. This is because this tool is not important to claim assets if a company goes bankrupt. In addition, bonds are relatively safe because investors can choose. state bond.

2. Investors turn to newly issued bonds.. The increase in the BI rate stimulates the expectation of increased profits that investors want. Consequently, bonds issued when the economy is improving tend to offer higher yields or coupons compared to previously issued bonds. As a result, the price of old bonds will decrease.

Rudiyan grew up in his youtube channel It also stated that the impact of monetary policy tools on bond prices will be more severe if bonds are longer-lived. For example, if the BI rate increases to 3%, bonds with maturities of 3, 5.7 and 10-years will fall by 0.5%, 1.5%, 2.9. % and 6% respectively. Conversely, if the interest rate decreases The maximum increase is also given for the longest bonds.

How to Calculate the Effect of Benchmark Interest

In addition to sharing theoretical aspects The director of Panin Asset Management also shares how to calculate the impact of financial variables on bond prices using a spreadsheet application such as Microsoft Excel. Here are the steps:

1. Collect debenture price information first.

The first step is to collect bond price information. If you buy government bonds, you can go to the statistics section of the page. Director General of K. Finance and Risk ManagementMinistry of Finance. If what you want to buy is corporate bonds You can view bond price information in the trading application you use or in the Indonesian stock exchange.

Since this is a trial You should gather information about the change in the price of a bond over a period of time, whether it be 6 months or a year. The goal is that the results of the analysis are more or less responsible.

2. Know BI rate change data

The second step is to find out about the increase in the BI rate so that the results of the analysis you performed are sufficient for the current conditions. You can get this information at BI website.

3. Keep the table organized.

The deal is:

• A1-A5: Date
• B2-C2: maturity period (5 years, 10 years, etc.)
• B3-C3: Bond Name
• B4-C4: Coupon Rate
• B5-C5: Due Date
• B6: Price.
• C6: Yield (the expected return of investors)
• After B6 and C6 can fill in the price and return on the relevant date.

If the price information is complete You can fill in the cells below with the following information:

• new rate of return
• projected price change
• the date you bought the bond
• Bond price set at maturity (100)
• Coupon payment frequency
• Daily is filled with number 1
• increase in interest rates

4. Set a new rate of return.

Yield is the rate of return an investor expects. Yield is generally defined as a percentage. To receive a new return after interest rates increase. You can add the return value to the latest data by increasing the interest rate. So, if the final return value is 5.6% and the interest rate increases by 0.5%, the new return will be 6.1%.

5. Enter the data in the last cell into the formula.

The last step is to enter a new rate of return. projected price change the date you bought the bond Bond price set at maturity (100), coupon payment frequency, daily threshold, and interest rate increase in function. price.

If all information has been entered All you have to do is click Enter and see the projected change in bond prices due to changes in interest rates (BI Rate).

Note that this method is only used to help estimate the impact of interest rate changes on bond prices. The underlying conditions may vary due to the large number of FOMO investors and potential daily bond price changes, whereas BI7DRR is only updated once a month. And Indonesia’s benchmark interest rate may not change at all in a few months.