What is Interest Sensitive Stock

An interest sensitive stock is a stock that is especially sensitive to changes in interest rates, including banks and companies that pay high dividends. Stocks, in general, tend to be sensitive to changes in interest rates. Low rates typically mean low interest rate expenses, and therefore higher levels of income. Low rates also affect valuations. Analysts use the risk-free rate when they determine the intrinsic value of a stock. And the rates on Treasury securities are used as the risk-free rate. A lower risk-free rate typically translates into a higher intrinsic value.

BREAKING DOWN Interest Sensitive Stock

Some stocks are especially sensitive to interest rates, and for other reasons. Not all these reasons are the same for these stocks. Utilities, REITs and telecom companies, for example, often pay high dividends and are therefore owned for the income they generate for investors. For this reason, these stocks are often referred to as "bond substitutes." Just as bond prices decline when interest rates rise, so do these bond substitutes. When interest rates rise, investors shift out of these sectors on the belief that they can gain a similar level of income without the risk that stocks present.

Homebuilders may also see their share prices fall when interest rates rise. Rising interest rates mean higher mortgage rates, which can translate into fewer home purchases. Companies with large debt levels will also be very rate sensitive, as their cost of borrowing is likely to rise.

Banks are also especially sensitive to interest rates. Much of a bank's income comes from its net interest margin, the difference in the rate it pays on its bonds (and on to its account holders) and the rate it charges on the loans it makes. Because a bank typically borrows on a short-term basis and lends on a long-term basis, rising long-term rates typically boost the net interest margin, bank income, and therefore the price of its stock.