11. Interest rates and their effect on corporate profits and investment prices Aa Aa Interest rates affect corporate profits and security prices. Based on your understanding of the relationship between interest rates and corporate profits and security prices, identify which of the following statements is true and which is false. False Statements True Interest rates will affect the preference of investors to own stocks versus owning bonds. Interest rates affect the level of economic activity, which in turn affects the profits earned by a business organization, all other considerations remaining constant. A sharp decrease in interest rates will increase the price of bonds, which significantly can decrease the potential for capital gains and the yield earned by a bondholder. This should decrease the demand for bonds compared to the demand for stocks, all other considerations remaining constant. An increase in market interest rates will increase the opportunity cost of investors' funds and increase the price of financial assets. To further examine the relationship between interest rates and the price of financial assets, consider the effect of a change in an investor's required return, or opportunity cost, on the price of a financial asset. Four years ago, Zachary purchased a perpetuity that agrees to pay him and his heirs $150 per month forever. At the time of purchase, Zachary was expecting to earn an annual return of 6.00%, but in the intervening years, the V economy and the available investment alternatives have changed. In today's market, it is now reasonable to anticipate an annual return of 3.60%. By how much would you expect the value of Zachary's perpetuity to change from when he purchased it until today? $30,000 $1,667 $50,000 $20,000