A dip in the stock market does not necessarily mean a dip in interest rates. In the United States, the Federal Reserve controls interest rates, raising them or lowering them as needed. If the rates rise, a company will need to pay more to borrow money, meaning its stock may go down, since it has more debt.
Interest Rates Explained
When you borrow money for a mortgage or car loan, you agree to pay more than the principal of the loan in interest. The bank that loans you the money most likely borrowed money from another bank and owes that bank interest. The interest paid by banks to each other is the fund rate. This rate can be raised or lowered by the Federal Reserve. It may lower the rate to encourage more money to flow through the system. The goal when raising or lowering interest rates is controlling inflation.
Why Interest Rates May Decrease
In times of recession or depression, such as when the stock market drops, the Federal Reserve may lower the interest rate to encourage borrowing and to stimulate the economy. For example, in December 2008, the Federal Reserve dropped interest fund rates to almost 0 percent, according to an article by Edmund L. Andrews and Jackie Calmes in the New York Times. The goal in reducing the rate was to prevent deflation and encourage the economy. Lowering the rates helped the stock market improve that day.
Stocks, or portions of a company, are sold in the stock market. The value of a company's stock is determined by several factors, such as demand for the stock, the amount of revenue and profit earned by the company and the company's past history. In some cases, outside factors, such as the death of a political leader, a natural disaster or an international banking crisis, can cause the value of the stock market to go down.
Higher Interest, Lower Stock
When interest rates are high, a stock may lose value. Investors typically look at a company's debts when determining whether or not a stock is a sound investment. The more debt a stock has, the less sound it is. When interest rates are higher, it appears that a company owes more debt than it would on the same amount in a time when rates are lower. Investors are less likely to purchase or may sell stocks in that case, causing the value to drop.
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