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Surviving interest rate fluctuations: Opportunities and challenges for investors

Updated: Apr 5

Understand the relationship between interest rate and stock prices. How rate hikes affect the stock market.

If you have been keeping up with the news, you have noticed how the Fed rate hike has caused stock prices to fall over the past year.

However, media outlets fail to explain the reasons behind this trend. Today, I want to shed some light on how interest rates can influence share prices in simple terms.

Impact of interest expenses on business profits

A lot of companies use debt to finance their daily business operations or fund expansion plans.

For instance, let us consider McDonald's, which has about $35.9 billion in debt on its balance sheet.

McDonald's has about $35.9 billion in debt on its balance sheet.

For simplicity, let us assume they are currently paying 3% interest on this debt, which amounts to $1.1 billion in interest expenses.

However, if they had to refinance this debt at a higher interest rate of 5% due to rising interest rates, their total interest expenses would almost double to $1.8 billion. This would significantly impact their overall business profitability.

Increased cost of debt reduces consumption

When interest rates are low, consumers are more likely to borrow money and increase their spending. However, as we saw in the McDonald's example above, rising interest rates can negatively affect consumers' disposable income.

For instance, if you hold a mortgage of $500,000 with a floating interest rate, a mere 2% increase in interest rates would translate to an additional $10,00 in interest expenses.

This means consumers would have less discretionary spending on goods and services, directly impacting business sales.

Effects of rising interest rates on small banks

Small banks may face higher costs of funds, which can put pressure on their margins. As interest rates rise, depositors may demand higher interest rates, and small banks may need to offer better rates to attract deposits.

Additionally, small banks may need to pay higher interest on their own borrowings, which can increase their cost of funds.

These small banks may also experience a decline in demand for loans. As interest rates rise, borrowers may be less willing to take out loans or may demand lower loan amounts. This can result in a decrease in loan demand, which can hurt the banks' revenues.

Fed hike threatens midsize banks which may spell troubles in the banking system.

Valuation of assets is sensitive to changes in interest rates

In financial modelling, the intrinsic value of a business is estimated by discounting its expected future cash flows back to the present using a discount rate.

The discount rate is typically influenced by the prevailing interest rates. When interest rates rise, the discount rate used in valuation models also increases, which reduces the present value of the business's future cash flows. This can result in a lower estimated intrinsic value of the business.

Conversely, when interest rates decrease, the discount rate used in valuation models decreases as well, leading to a higher present value of the business's future cash flows and a potentially higher estimated intrinsic value.

In simple terms, higher interest rates can decrease the estimated value of a business, pulling down the asset price.

It is not all doom and gloom

During times of high-interest rates or a potential recession, some companies may have the advantage of not relying heavily on external capital. These companies typically have a strong balance sheet or reliable cash flow streams.

With this financial strength, they can take advantage of opportunities during challenging economic times.

Firstly, they can choose to buy back their shares at depressed prices, which can help to boost the value of their remaining shares and benefit existing shareholders.

Secondly, they may have the ability to acquire competitors who may be struggling and have depressed prices, allowing them to expand their market share or consolidate their industry position.

Alphabet authorize $70B shares buyback during economically difficult times.

By utilising their financial stability and taking advantage of favourable market conditions, these companies may be well-positioned to capitalise on the situation and potentially benefit in the long run. Investors can consider such companies in their investment strategies during high-interest rate environments or economic downturns.

Looking at the economy as a whole, one benefit of rising interest rates is to control inflation.

When interest rates are low, consumers are more likely to borrow money and spend it, which can lead to an increase in prices. By raising interest rates, central banks can reduce the amount of money that is circulating in the economy, which can help to control inflation and ensure that prices remain stable.

Furthermore, when interest rates rise, it can make a country's currency more attractive to foreign investors.

This can lead to an increase in demand for the currency, which can strengthen its value relative to other currencies. A strong currency can help to reduce the cost of imports, which can help to lower inflation and support economic growth.


Interest rates play a crucial role in influencing various aspects of the financial world, including stock prices, consumer spending, asset valuation, and business intrinsic value.

When interest rates rise, they can impact business profits, reduce consumer spending, and lower asset prices. Understanding the relationship between interest rates and these financial factors is important for investors to make informed decisions and navigate the ever-changing landscape of the financial markets.


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