Impact of Interest Rate on Stock Market

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Stock Market

Introduction
The purpose of this paper is to discuss the impacts that change in interest has on the stock market. In order to do this analysis, it is important to understand the implications of interest rate on stock market and how both the changes that is an increase and decrease has different effects on the securities that are operating in the commercial market. The paper further will do an analysis of effect of interest rates on stock market of USA as this country is one of the fastest growing and largest economy in the world and their changes must be studied in order to understand the big picture regarding the securities market and the effects that is imposed on the market due to a rise or fall in the interest rates (Alam and Uddin 2009)

Discussion Related to change in interest rate
To get a significant grab on the whole concept first it is important to understand how interest rates changes. Sometimes it is done purposefully to counter the effects deflation in some economy like Japan where deflation has been a major problem for several decades and sometimes it happens due to market forces. Here market forces are not only demand and supply but also the spending habits of the people in the society. Spending habits can be impacted by reducing or increasing the purchasing power of consumers which can be achieved by a higher rate of interest. Anyway, interest rates changes money supply and in return counters inflation by reducing the purchasing power of consumers. This changes because of financial institution policies and when they feel that government should order for a change as they constantly observe the market forces and how they change the behavior of the market every day, as changes does not happen in one day or even one week. Months of observations are done before real impacts can be analysed and that is why financial experts are given this hard task (International Journal of Science and Research 2017).

However, there can be only two kinds of change in interest rates, that is, either it can increase or it can decrease. Both have different effects from each other. In case the beneficial effects of interest are considered then a slow rise in interest rate actually proves to be beneficial for the market. In spite of the fact that expenses may rise somewhat if loan fees are step by step raised, benefit development by and large surpasses these expenses. Higher benefits, thus, commonly lead to higher stock costs. The particular industry that explicitly profits by rising loan costs is the money related administrations industry or the financial institutions. Banks make benefits from paying investors lower, transient rates and loaning that cash out at longer, higher-term rates. At the point when rates tick higher, banks can charge more for credits. On the other hand, in case the interest rate has a negative effect it results to higher loan fees which rises the expenses for organizations in terms of taking credits. This specifically diminishes corporate profit. Further, higher financing costs may keep organizations from assuming extra obligation for capital consumption. Without extending activities, it winds up more earnestly for organizations to develop their benefits. Both of these elements can trigger lower stock costs (Iglesias and Haughton 2013).

Key effects on the stock market
The interest that changes the market is the federal fund rate. This is the rate at which depository institutions are charged for their borrowings from reserve banks. This is used by the regulating authority to control inflation. On the other hand, when it diminishes the government subsidizes rate, the reserve bank is expanding the cash supply and, by making it less expensive to acquire, empowering purchasing power (Tai 2000).

To study the impact of interest on stock market it is important to understand that the whole thing is a chain process where things happen eventually step by step. Change in interest rate does not affect the share market directly but affects through several other factors. The main effect is that the rate of borrowing for banks increases. So, as it costs them higher amount of money to obtain cash, budgetary foundations frequently increment the rates they charge their clients to acquire cash. People are influenced through increments to charge card and home loan financing costs, particularly if these credits convey a variable financing cost. This has the impact of diminishing the measure of cash buyers can spend. All things considered, individuals still need to pay the bills, and when those bills turn out to be increasingly costly, family units are left with less extra cash. This implies individuals will spend less optional cash, which will influence income and expense of an organization (Kurihara and Fukushima 2014).

Now it is the business entities that are also affected both directly and indirectly as they borrow from banks with higher interest which increases their cost of operation. If several companies face a fall in their stock prices the whole market experiences a downfall in this regard as they are all connected financially. In between all these, there is one sector that actually benefits from an increase in interest rates that is the financial institutions. Banks, businesses, contract organizations and insurance agencies’ income frequently increment as financing costs move higher, on the grounds that they can charge more to loan (Galí and Gambetti 2015).

In a report published by Presidency University of Bangladesh along with an officer of CRM, it stated that both stock and interest are crucial for the commercial market. The effects of loan fee on stock trade give vital ramifications to monitory approach, chance administration rehearses, monetary securities valuation and government strategy towards budgetary markets. This examination and observation of this report inspects the proficiency of stock trades and furthermore looks about the impact of offer cost and development of offer costs on loan cost and development of financing cost (Chkili and Nguyen 2014).

Short term impact- The short-term instant effect that interest rate has is on the companies with high amount of debt in the market. This results in depletion of stock prices because they need more money to borrow from banks.

Long term impact- Higher interest rate impact several industries in the long-run and the industries which are most affected by high financing cost is the land, car and all the capital concentrated ventures. In this way, any venture by speculators in these divisions must be taken with a great deal of alert amid the circumstance of high financing costs (Galí and Gambetti 2015).

Hence, when interest rates are lower the fixed deposits in banks becomes for vulnerable as an option for the consumers which subsequently would leave the manages an account with much lower cash to loan out to the borrowers, and their net revenues would likewise be influenced by lower financing cost. Hence there would be a fall in utilization and speculation exercises in the economy. The administration in this circumstance would depend on printing of cash to send more cash in to the market as a piece of monetary shortage which may prompt inflationary state in that economy (Galí and Gambetti 2015).

Conclusion
To conclude, it can be said that, interest rate has deep positive and negative impacts on the stock prices which as a result affects the whole economy. Some industries are directly affected whereas some are beneficially affected. However, rise in interest rate is not something that is generally preferred that can be observed from the above discussion and various studies done by financial experts. Anyway, a change in stock prices which has negative impact on the economy is almost never a party of any government’s policy unless it is the only step to save the economy.

Reference
Alam, M. and Uddin, M. 2009. Relationship between Interest Rate and Stock Price: Empirical Evidence from Developed and Developing Countries. International Journal of Business and Management, 4(3).

Chkili, W. and Nguyen, D.K., 2014. Exchange rate movements and stock market returns in a regime-switching environment: Evidence for BRICS countries. Research in International Business and Finance31, pp.46-56.

Galí, J. and Gambetti, L., 2015. The effects of monetary policy on stock market bubbles: Some evidence. American Economic Journal: Macroeconomics7(1), pp.233-57.

Iglesias, E. and Haughton, A. 2013. Interaction between monetary policy and stock prices: a comparison between the Caribbean and the US. Applied Financial Economics, 23(6), pp.515-534.

Kurihara, Y. and Fukushima, A. 2014. Exchange Rates, Stock Prices, and Commodity Prices: Are There Any Relationships? Advances in Social Sciences Research Journal, 1(5), pp.107-115.

Research on the Relationship between Interest Rate and Stock Price in China. (2017). International Journal of Science and Research (IJSR), 6(7), pp.2093-2099.

Tai, C. 2000. Time-varying market, interest rate, and exchange rate risk premia in the US commercial bank stock returns. Journal of Multinational Financial Management, 10(3-4), pp.397-420.