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Evaluating Explanations for the Interest Rate-Share Price Link
An economist states, 'A rise in market interest rates will cause share prices to fall.' Two students offer different explanations for this statement.
- Student A argues: 'The rise in interest rates increases the cost of borrowing for companies. This reduces their profitability and their ability to pay future dividends, which makes their shares less valuable.'
- Student B argues: 'The value of a share is the present value of its expected future dividends. A higher interest rate is used to discount these future payments, which mathematically reduces their value in today's terms, thus lowering the share price, even if expected dividends don't change.'
Critique both arguments. Which student provides the more fundamental and direct explanation for the relationship between interest rates and share prices? Justify your choice.
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Introduction to Macroeconomics Course
Ch.5 Macroeconomic policy: Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
The Economy 2.0 Macroeconomics @ CORE Econ
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