4 Replies to “what is the relation between bank interest rates and sharemarket. How and why bank interest rates affect?”

  1. try this,

    The debt market affects your investments and returns more than you think and influences all your personal investments, whether in fixed income avenues such as PPF or debt funds — or in equity. Here is how.

    That changes in interest rates affect returns from fixed-income investment avenues is obvious Equally, changes in interest rates have profound impact on the direction of the stock market. In fact, interest rates are a key driver of the stock market.

    Unfortunately, many individual investors miss the many signals that the debt market offers the more astute investor. These signals can present opportunities — or serve as warnings — in a wide variety of personal financial matters, ranging from home loans, credit cards, personal and car loans to investing in the stock market, and, of course, fixed income investments.

    The Indian debt market comprises broadly of government securities (G-Secs) and bonds – PSU Bonds, bonds issued by financial institutions such as ICICI and IDBI, and corporate bonds and debentures, with G-Secs being the most dominant. Unlike in developed countries such as the US where the debt markets are significantly larger than the stock market, in India the situation is the reverse. The reason: interest rates in India were till recently strictly regulated and the number of players in the debt market relatively few. The de-regulation of interest rates, however, is now changing all that. A freer interest rate regime, with frequent changes in interest rates, obviously leads to fluctuation in the returns from fixed income instruments. Indian investors have of late discovered this to their dismay as the lowering of interest rates offered on ever-green instruments such as PPF, NSCs, bank deposits has eaten into their income returns.

    How Interest Rates Affect Share Prices

    The impact of interest rates on your personal finances extends well beyond your debts. Interest rates affect your equity portfolio, too. There is plenty of evidence. Indeed, in history to prove that interest rates can have a profound impact on the stock market. As a result, the stock market watches the bond market like a hawk. Stock market professionals respond predictably to the RBI’s periodic raising or lowering, of interest rates.

    By gaining a better understanding of the debt market, you can recognise the potential risks and opportunities that movements of the debt market present for equity investment. A clear grasp of the goings-on in the debt market will help you understand how it affects the stock market and refine your investment decision-making process.

    There are basically six ways in which changes in interest rates affect the stock market investor:

    1. Changes in interest rates directly affect corporate profits. Companies need to borrow funds to finance expansion programmes, meet working capital requirements, purchase equipment and maintain inventories of raw materials and finished goods. Low interest rates lower the cost of money and increase the profit margins of companies. Since share prices are directly linked to corporate profits, the lowering of interest rates always has a bullish effect on the stock market.

    2. Changes in interest rates affect the general demand for goods and services in the economy. When interest rates are lowered, people tend to spend more and save less. When interest rates are raised the reverse happens. Increased consumer spending as a consequence of lower interest rates leads to an expansion in the demand for the goods and services provided by the corporate sector.

    3. Changes in interest rates have a direct effect on the sales of automobiles, commercial vehicles, two-wheelers, tractors, agricultural equipment, consumer durables (television sets, washing machines and kitchen appliances) and increasingly housing since the demand for these products is significantly dependent on borrowed funds. Lower interest rates also spur to construction activity through a reduction in the cost of housing finance. Therefore, falling interest rates are good for automobile, two-wheeler, tractors, farm equipment, cement, construction, steel, consumer durable and housing finance companies.

    4. Changes in interest rates also alter the relative attractiveness of competing financial assets like shares, bonds, and other fixed-interest investments. Lower interest rates generally tend to cause a shift of investible funds from bonds, bank and company deposits to equity shares and vice versa.

    5. Changes in interest rates affect the way companies finance their operations. During a high-interest-rate regime, companies prefer to raise funds through issue of equity shares rather than through bonds and high-cost bank loans. When interest rates fall, bank loans become a cheaper source of finance than equity, and companies prefer to borrow money from banks and raise their debt-equity ratios. In short, lower interest rates are bad for the primary market and good for the secondary markets.

    6. Lower interest rates also reduce the cost of borrowing money for the purchase of shares. This is another way in which the lowering of interest rates has a bullish effect on the stock markets.

    In sum, a lowering of interest rates generally lifts the stock market. Conversely stock market tend to slip as interest rates rise. This is not to say that this happens in perfect co-ordination . It takes time for changes in interest rates to work their way through the markets in the manner described above. For an alert investor, though, changes in interest rates offer pointers to switch from debt investments to the equity market when interest rates fall and vice versa.

  2. Be in bank interest or earning through share market. Every one wants more money safely.

    When bank interest rates fall, normally people tend to inflow money in share market to earn better. Thats why whenever interest rate falls , share market increases.

    Bank interest rates depends on various factors like
    Reserves of cash etc, with banks, RBI or any other governing policy, global interest rates, credits/loans etc.

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