How do changes in interest rates affect equity prices?
In the example on the
efficient market hypothesis
wiki, we said that in a market where the "riskless rate" is 4%, the risk premium is 2%, the dividend yield is $2, and the expected growth rate is 2% then the stock, priced only as the present value of the expected value of the stream of future dividends, should be worth $50.00.
This follows from the formula:
What happens when the interest rate rises to 5%? How much should the stock price increase or decrease if nothing else changes?
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1 solution
Original calculation being as follows: And With 5% interest rate instead of original 4% it changes to: 0.06 = $2.00/P+0.02 0.07=$2.00/P+0.02 0.04 = $2.00/P 0.05=$2.00/P P=$2.00/0.04 = $50.00 P=$2.00/0.05 = $40.00 = Price decreases 10$ from 50$ to 40$