Effect and significance of interest rate cuts by Fed.

When I think of this topic, some of the questions that pop into my mind are:

What interest rates are we talking about? Which rates are the fed cutting? Why is it cutting the rates and what is the significance of such rate cuts? How does it help the economy? Does it have any bad effect? To what extent can the fed cut such rates? What can we predict looking at the past interest rate cuts and is there any information we can extract based on the trends we see? How does the various factors in the market react to this rate cuts or increases? How does it effect globally?

The advantage of being an MBA is that you may not know the answers to many of these questions but you can start asking questions. Let me try and address these one at a time.

Although the relationship between interest rates and the stock market is fairly indirect, the two tend to move in opposite directions. Here's why.

A decrease in interest rates means that those people who want to borrow money enjoy an interest rate cut. But this also means that those who are lending money, or buying securities such as bonds, have a decreased opportunity to make income from interest. If we assume investors are rational, a decrease in interest rates will prompt investors to move money away from the bond market to the equity market. At the same time, businesses will enjoy the ability to finance expansion at a cheaper rate, thereby increasing their future earnings potential, which, in turn, leads to higher stock prices. Investors and economists alike view lower interest rates as catalysts for expansion.

Overall, the unifying effect of an interest rate cut is the psychological effect it has on investors and consumers; they see it as a benefit to personal and corporate borrowing, which in turn leads to greater profits and an expanding economy.

If you have answers to any of the questions above then please comment.