Unit 2 · Level 3 · Rates → assets
The discount-rate machine
A promise of €100 next year is worth less than €100 today, and how much less depends on the interest rate. Raise the rate, and every future cash flow shrinks in today's money; the further away the cash, the harder it shrinks. This one mechanism, discounting, is how a central bank decision reaches every asset you own.
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What you get asked
Why do higher interest rates tend to lower asset prices?
An asset is a claim on future cash. Raise the discount rate and that future cash buys you less present value, so the price falls, mechanically.
Two assets each promise €1,000: one pays next year, one in 30 years. Rates jump. Which price falls more?
Discounting compounds: each extra year is another division by (1 + rate). Thirty divisions hurt far more than one.
Order the chain from rate decision to asset prices
One decision ripples outward: safe yields reset the bar, discount rates rise everywhere, and assets living furthest in the future feel it most.
The further in the future a cash flow sits, the ___ a rate rise hits its present value.
Discounting compounds year after year, so distant cash flows are the most rate-sensitive. That's the whole idea of duration.
'Duration', in this unit's sense, means:
Duration is about the timing of value, not the age of the asset or your holding period. Distant value = long duration = big rate sensitivity. 🐜
The rest of this unit
Interest rates are financial gravity. Trace how one number reaches every asset you own.