Negative Rates in Europe: Implications for Finance Teaching and Practice

ABSTRACT

Many European countries have introduced negative interest rates, and the Swiss franc denominated bonds of many US companies now trade at negative yields. Why do central banks push interest rates negative and what are the costs of benefits of doing so? How much more negative can rates go or have we reached the limit in some countries? How does a bank remain profitable when you have to pay your borrowers to take money from you? How do investors allocate their portfolios in an environment where the government bond is offering not a risk free return, but a guaranteed loss? What happens to the equity risk premium in such a world? How do companies manage working capital in a situation where you want to pay your suppliers instantly and want your customers to delay their payments to you? What happens to standard present value formulas in a negative rates world? Does the present value of perpetuities actually become negative? These are a few of the disturbing questions that arise when negative interest rates upend our traditional assumptions about how the financial system works. Our article addresses these questions from the point of view of managers and educators trying to make sense of this brave new world.

KEYWORDS

Corporate finance, Interest rate models, Monetary policy, Option pricing, Negative rates, Risk management, Zero lower bound

Cite this paper

Jayanth R. Varma, Vineet Virmani. (2019) Negative Rates in Europe: Implications for Finance Teaching and Practice. International Journal of Economics and Management Systems, 4, 259-271