Infrastructure

[Amigo]

Hello,

On page 17 of Unit 5 of the core reading it mentions that with rising interest rates the value of the infrastructure asset will fall initially, but this will be offset by increase in future revenue.

I would like to understand if the increase in future revenue is because it is inflation-linked (say a toll bridge) and inflation is the reason behind rising interest rates?

My understanding is there could be other reasons for rising interest rates - like defending weak domestic currency which could reduce demand depending on elasticity of demand (from alternatives to the toll bridge) that could potentially reduce future receipts.

Please let me have your thoughts on this.

 

[Colin McKee]

Hi, I think you are right. The wording is quite woolly and could mean a number of things, but as you say, if a pnsion fund buys a long dated bond whose coupons are the securitised revenue from renting out a hospital for 30 years, then when interest rates increase we would expect the discounted value of the bond to fall. If however, interest rates have gone up because the economy is growing too strongly or inflation is taking off, then we would expect the hospital rents to increase over time. This would increase the revenue stream and return the value of the bond to its former glory. Hence they are often referred to as real assets, unaffected by inflation oer the long term.

 

[Amigo]

Thanks. Much appreciated.