Infrastructure investments

[omurice]

Hi,

In Chapter 5 Page 28 of the Course Notes, under infrastructure investments, why is initial reduction in value caused by rising interest rates will be offset by revenue as the underlying asset grows? Isn’t the initial value estimated from present value of future cash-flows which already includes revenue?

The next sentence then states that revenue increases are driven by growing economy and inflation. Shouldn’t inflation rates drop and economy growth decreases as a result of rising interest rates?

Thank you so much.

 

[Colin McKee]

Over the medium to longer term however, any initial fall in value as interest rates rise is mitigated as revenue from the underlying asset grows.

You are right that the bond value will be calculated as the PV of cashflows. So as long-term interest rates rise, the value of the bond falls - this is referred to as the "initial fall in value" in the quote above. I believe the second part of the sentence might be referring to bonds where there is an inflation or revenue linkage in the coupons. So over the longer term, despite the fall in value, the investor will see income rise with inflation and with the growth of revenues from the infrastructure asset.

The next sentence then states that revenue increases are driven by growing economy and inflation. Shouldn’t inflation rates drop and economy growth decreases as a result of rising interest rates?

Inflation and economic growth will normally drop when "short interest rates" rise. But the infrastructure discussion is about long term interest rates, ie bond yields. The second sentence does not try to link lower long term yields with higher inflation - it simply reiterates that over the very long term, revenue to the investor should grow as the economy grows and the asset revenues grow. I think this assumes that the infrastructure bond is not fixed interest, but has some inflation or revenue linkage.