Interest Rate Volatility

We know that debt is a vital source of financing for corporations, and interest rates are a key component of a firm's cost of capital. Up until 1979, interest rates in the United States were relatively stable because the Federal Reserve actively managed rates to keep them that way. This goal has since been abandoned, and interest rate volatility has increased sharply. Figure 23.2 illustrates this increase by plotting the changes in five-year Treasury bond rates. The increase in volatility following 1979 is readily apparent.

Before 1979, U.S. firms were able to plan for and predict their future borrowing costs with some confidence. In today's financial world, because of the increased uncertainty surrounding interest rates, this is no longer the case.

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