The increase in interest rates has a series of direct and indirect effects on the different types of investment. In general, increase rates have a negative impact on long-term values, but they can have the opposite effect on short-term values. Rate changes do not directly affect the shares, but the economic impact of the increases usually decreases the price of the shares.
Debt instruments are directly affected by interest rate increases because debt instruments are securities in which investors earn interest. These titles have the form of bonds and mortgages. If you keep debt security until it expires, you will receive a return of the premium from the issuer of the debt. However, if you sell it to another investor before it reaches maturity, you might have to sell it at a reduced price if similar debt securities are available, but of more recent issuance that pays more.
When rates rise, many investors move their funds to high liquidity and short-term instruments such as bank certificates of deposit or money market accounts. If the types of short-term instruments are comparable to the rates of the higher fixed-income securities, in the long term most investors choose the liquidity provided by the short-term instruments over the long-term non-liquid instruments. Therefore, cash flows in interest investments that pay in the short term usually increase when stocks rise.
In general, short-term bond prices are not greatly affected by interest rate increases because investors do not have to wait long to get a return on the premium and are unlikely to reach an agreement to sell at a discounted price.
When interest rates go up, investors have to spend a larger percentage of their money on debt payment because credit card rates, car loan rates and mortgage loan rates begin to increase. Consequently, investors have to reduce their other expenses due to a loss of purchasing power. This means that people have less money to invest and since stock prices are partially driven by supply and demand, stock prices fall every time investors have less disposable income.
Apart from supply and demand, share prices are also driven by the performance of the companies that issued the shares. Investors who depend on dividend income are negatively affected when dividends are cut and investors often turn to other types of securities when dividend cuts become widespread. When interest rates are going up, loans become more expensive for businesses as well as for people and this causes business profits to fall. Lower profits lead to lower dividends and falling stock prices. Therefore, the increase in interest rates has a negative impact on the value of the shares.