Corporate Finance

• Corporations raise capital by issuing both shares of stock and debt to creditors. In exchange for loaning money out to corporations, creditors collect interest payments on their bond and money market securities. Alternatively, shares of common stock represent ownership stakes within the corporation. As ownership stakes, share prices generally track corporate profits. For individual corporations, low interest rates that reduce financing costs should translate into improved profitability and higher share prices. Consequently, a corporation may struggle to make its debt payments due to high interest rates. Share prices would then collapse toward zero if the corporation faced the prospects of loan default and bankruptcy.
  
  

Competing Investments

• Common stock investments compete against bank deposits and fixed income securities for investment dollars. Compared with common stocks, bank deposits and fixed income assets, such as bonds, are low-risk investments. In a high interest rate environment, share prices are likely to fall as money flows out of the stock market and into bank deposits and fixed income. With high interest rate payments, these conservative investments offer decent returns for minimal risk. In a low interest rate environment, however, investors are more so likely to accept stock market volatility for the opportunity to earn high investment returns. When interest rates are low, bonds and bank deposits make minimal payouts.
  
  

Federal Reserve

• In the United States, the Federal Reserve Board manages the prevailing interest rate environment through its influence over the money supply. When the Fed seeks to lower rates, it enters financial markets to purchase U.S. Treasuries for cash and increase the money supply. The Fed works to lower interest rates amid recession to stimulate the economy by encouraging people to take out loans and invest money. Stocks, overall, often post strong gains in response to news of a Fed rate cut. Alternatively, the Fed will sell Treasuries to restrict the money supply and target higher interest rates when inflation is a concern. Over time, stock market returns are likely to deteriorate when the Fed begins a campaign to raise interest rates.
  
  

Investment Strategy

• Stock market sectors that rely heavily on borrowing money, such as utilities, banks, insurance companies, and brokerages, are especially sensitive to interest rate trends. As a beginning investor, however, it may be difficult for you to anticipate interest rate trends and trade accordingly. A diversified portfolio of money market securities, bonds, and stocks will provide for growth and help you to manage risks. When interest rates are high and remain stable, your bond and money market assets will generate significant interest payouts. When interest rates fall, your stocks should appreciate in value.