MACROECON HELP! The Federal Reserve unexpectedly lowers interest rates by 25 basis points (0.25%).?

Question

The following question focuses on an imaginary company called Bearsmith Consulting (BSC). A share of BSC currently sells for $50, and each share pays no dividends.

The Federal Reserve unexpectedly lowers interest rates by 25 basis points (0.25%). All else constant, we expect the stock price to ___.

A. Stay the same

B. Fall

C. Rise

The chief accountant for BSC is accused (though not convicted) by the Securities and Exchange Commission of not reporting a few minor losses that the company faced in the past three years. The accusation increases the perceived risk of holding this stock because investors feel that BSC could be withholding financial information on MAJOR losses. All else constant, we expect the stock price to ___.

A. Stay the same

B. Fall

C. Rise

Answer 1

1) C. Rise

When the Federal Reserve UNEXPECTEDLY lowers the interest rates, stock prices generally rise since companies can acquire loans at lower interest rates.

2) B. Fall

If the perceived risk of the company increases investors will be less willing to hold shares of the company. Thus for the same number of shares to be held, the price of the shares will have to fall.