In theory, rational investors will select an investment with a return that is high enough to compensate for the lost opportunity of earning interest from the guaranteed Treasury note and for taking on additional risk. If the required return rises, the stock price will fall, and vice versa.
For investors to invest in something riskier than the safe Treasury note, or risk-free rate, they require a higher return or risk premium. The direction of interest rates impacts a company's theoretical value and that of its shares, and therefore the risk premium.
According to financial theory, interest rates are fundamental to company valuation, and therefore play an important role in how we put a price on stocks. Here we take a look at the relationship between interest rates and stock price.
Finally, high interest rates normally go hand-in-hand with a sluggish economy. They prevent people from buying things and companies from investing in growth opportunities. As a result, sales and profits drop, as do share prices.