Generally, there is some link between the stock market and the interest rate. It is essential to understand the concept in order to understand how the stock prices affect the rate of interest and how interest rate affects the prices of the stocks.
We all have come across the term interest since our childhood. This is the percentage of money which we pay for utilizing someone else’s money. Most commonly, one uses the bank money for various purposes. They get loans from bank which could be a home loan or a car loan. It depends on the requirement of the person. But when it comes to the interest rate which is implied to the investors the significance of it is quite different. Here it is referred to the U.S. Federal Reserve discount rate. Here the banks are charged interest rate while borrowing money from the federal banks. This is the cost which is referred here. So to control the rate of inflation the FED changes the discount rate accordingly.
As the changes are done by the fed the implications can be seen on the bank rates as these banks in turn charge the customers with increase in the interest against loans. When the interest rate is increased the household have minimum money to spend. They do not indulge in further borrowing as the interest rate is very large. Therefore there could be seen overall decrease in the spending. Obviously, when the spending decreases there could be seen massive decrease in the rate of profit of the companies. Thus this lowers the value of the stock of the company.
Interest Rate and The Equity Portfolio
The equity portfolio is affected by the interest rates. The stock market leads to a drastic effect on the interest rates. Therefore on has to understand the risk and the opportunities that are available in the market. The interdependence of this must be understood clearly so that a person can get an understanding of the market position and invest in a better manner. When the stock prices go down the impact of this can be directly seen on the interest rates as the bank’s capital assets are affected with the market movement.
Banks tend to sell the financial products to their customers. In this process the stock market and the prices of the stocks are directly affected. So it can be seen that the interest of the customers in mutual funds decreases. There could also be possibility that the customer loses plenty of money when the market declines. Therefore the reaction of the user to the stock market affects the interest rates laid down by the bank.
Ultimately it could be seen that the effect in the stock market leads to less profits, the banks need to borrow from the Federal Reserve banks and which leads to less money in the hands of people and these banks charge increase in interest, so there is less to spend and this leads to fall in profits and stock prices.