Floating and Fixed Rate: Key Principles - Special Academic Support

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Choosing a floating or fixed interest rate is an important decision. Depending on external facts, one can either make money or incur significant losses. There are certain rules and indicators in which it is necessary to choose a floating and a fixed rate. Moreover, there is a theory of market efficiency, according to which any significant information immediately affects the market value of securities (Lahiri, 2021). In addition, there are several types of market efficiency, depending on the scale, time, and influence of information production. A weak form of efficiency is if the value of a marketable asset fully reflects past information regarding this asset. The average condition of efficiency is if the value of a market asset fully reflects not only past but also public information. A strong form of efficiency is if the value of a market asset fully reflects all information past, public and internal.

Assuming that the market efficiency hypothesis is correct, a fixed rate should be chosen. First of all, it is formulated by the fact that the risks can significantly exceed the benefits. Today, any information, both past, present, and future, has a significant impact on assets. An example is the mention of any companies by famous people, after which the share price increases significantly. However, it can backfire when a well-known person speaks negatively about the campaign, and the stock crashes. One cannot foresee how external factors will affect the company, respectively, cannot predict all the risks. Moreover, in a downtrend, a fixed rate is usually chosen, however, there is a risk that the share price will increase. Alternatively, if the main objective of the borrower is risk reduction, it is better to use a fixed rate. Although debt may be more expensive, the borrower will know precisely what his assessment and repayment schedule will look like and its cost.

Reference

Lahiri, M. (2021). Semi-strong form efficiency of Indian stock market in post-reform period. Walnut Publication.

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