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Fully discuss and answer the following questions and provide examples if applicable.


Question 1: What is the impact of interest rate cuts on bond prices?


Question 2: What is the relationship between interest rates and the cost of capital?


Question 3: What is the impact of cheaper borrowing on the firm’s investment decision?


Question 4: What is the impact of lower interest rates on the firm’s tax bill?


Question 5: What is the impact of the rate cut on one’s retirement income?




View the following links which contain videos and articles about interest rates. 


Interests Rates and Housing Market in New Mexico




CNBC on outlook for investments for 2011




CNBC on interest rates and inflation




CBC video on impact of rising interest rates




Article on Rising Interest Rates






*      An interest rate cut might result in a major boost for the economy or might go unnoticed, depending on the circumstances. In theory, lower interest rates would entice the consumer to borrow more and spend more. Moreover, a lower interest rate would also make corporate borrowing cheaper. Cheaper borrowing should translate into firms taking  on more investment projects, expanding and creating more jobs and income.


*      When interest rates are low, more investment opportunities become attractive (given that other things stay constant). This is true because the cost of capital tends to be lower and therefore the present value of various projects tends to be higher. In general, the time-value-of-money impact of an interest rate cut is this: the future value gets smaller, while the present value of cash flows gets larger. By contrast, an interest rate increase—one that usually occurs when the economy is heating up—will have the opposite impact. It would lower the present value and increase the future value of cash flows.


*      Just like corporations, in the wake of an interest rate cut, investors have to re-evaluate their objectives and strategy. Take for example the proverbial risk-averse investor who puts all of his or her money into a savings account with the local bank. With a lower interest rate, our investor is now contemplating a lower terminal value of his or her investment. At the same time, the family who saves for their children’s education will now have to put aside a larger chunk of their income to meet the expected future cost of tuition and living expenses.





The following additional resources may help you.


*      Bank of Canada:


*      Mortgage Rates:


*      Financial Tools and Calculators:


*      Bond Price Calculator:


Grading Rubric


Answers to Questions

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