General Stock Investment Strategies/Interest Rates & Stock Prices

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Question
Hello:

Why does raising the interest rate by the Federal Reserve have a negative effect on stock prices?

I thank you for your reply.

Answer
Hi Kenneth,

Interest rates are one factor that impacts stock prices. It is certainly not the most important factor, which would be earnings. The present value (current price) of any investment including a stock can be determined by discounting its future cash flows to the present by using a model. The way we discount future cash flows back to their present value is by using an interest rate.  If you raise the interest rate, the present value of the future cash flows will be lower.  Another way to look at it is if rates increase, the cost of borrowing will be higher (more costly) for companies and as a result, expenses will rise and earnings may fall.  Lower earnings would negatively impact stock prices.

I hope this helps.
Michael

General Stock Investment Strategies

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Michael Weiss, CFA

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I can answer most questions about stock investment strategies, especially those related to value and growth

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I am the owner of Series 7 Exam Tutor , a financial tutoring business that provides personalized tutoring for the Series 7 Exam, the Series 6 Exam ,the Series 65 Exam, the Series 66 Exam, the Series 63 Exam and the Series 24 Exam . I also offer tutoring for finance courses. For additional information, please visit, Finance Exam Tutor. Prior to launching Series 7 Exam Tutor, I worked in investments for 20 years with the majority of this time focused on investment analysis and portfolio management. I have worked for large companies such as Merrill Lynch and Evergreen Investments and have also worked for smaller firms as well. Throughout my career, I have sought to mentor younger colleagues whenever possible, especially those enrolled in the CFA program. I completed the CFA program in 2002 after passing all three exams on the first try. I also passed the Series 7 Exam with a score of 94%. For additional information about me, you can visit the links below:
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Organizations
CFA Institute and CFA Society of Philadelphia

Publications
Investopedia

Education/Credentials
M.B.A. in Finance & Investments from the Zicklin School of Business at Baruch College and a B.A. in Finance & Economics from the City University of New York Baccalaureate Program.

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