Certified Financial Management Specialist Practice Exam

What relationship exists between falling interest rates and stock market performance?

1. Higher stock performance

2. No significant relationship

3. Lower stock performance

4. Increased volatility in stock prices

The correct answer is: Higher stock performance

When interest rates fall, it generally leads to higher stock performance. This occurs for several reasons. First, lower interest rates reduce the cost of borrowing for consumers and businesses. This can stimulate economic growth, as consumers are more likely to spend, and companies may invest more in expansion, both of which can boost corporate profits and, subsequently, stock prices. Additionally, lower interest rates make fixed-income investments, such as bonds, less attractive due to lower yields. As a result, investors may seek higher returns in the stock market, increasing demand for stocks and driving up their prices. The relationship derives from the interplay between corporate profitability, consumer spending, and investor behavior influenced by the prevailing interest rate environment. Moreover, when rates drop significantly, the present value of future cash flows from stocks becomes more favorable, further enhancing stock valuations. This cumulative effect illustrates why falling interest rates are often associated with improved stock market performance, corroborating the answer that indicates higher stock performance.