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Interest Rate and Market Value

The effect of an interest rate change on the market value of a Financial Institution's equity is a function of three things.

What are they and how do the affect the equity value change?

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The effect of an interest rate change on the market value of a Financial Institution's equity:

Interest rate change equates to interest rate risk facing financial institutions and this represents financial institution's cash flows, earnings and market value of equity or economic value sensitivity to interest rates changes. FHFB Office of Supervision (2007) provides that interest rates affect banks' earnings and capital by altering net interest income, balance sheet items' market value and income and expenses that are sensitive to interest rate. The financial institutions market value of equity is affected by changes in earnings, stock, and valuation of assets and liabilities.

Changes in interest rate affect net income and retained earnings since it affects financial institutions' net interest income as interest rate change determine interest paid on liabilities such as deposits and interest earned from assets. Net interest income is dependent on the composition of assets and liabilities held by a financial institution (Nissim & Penman, 2003). When a financial institution has higher assets compared to liabilities an increase in interest rate will lead to increase in net interest income since they receive more income from assets thus increasing the market value of financial institutions' equity.

Interest rate change also affects an organization's stock value, therefore, affecting the market value of equity. Interest rate affects earnings ...

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The following posting helps with problems involving interest rate and market value.