Question

Edge Company is a small company that has a volatile stock price for the past year, with an overall downward trend, but the Fed just announced that the discount rate is going down, as well. Is the price of Edge Company's stock likely to rise or fall? Explain your prediction.

Answer 1

The stock price is likely to rise.

Step-by-step explanation:

A fall in the rediscount rate, as announced by the Fed, is an expansionary monetary policy. Lowering the rediscount rate means that commercial banks will be able to borrow from the FED at a lower interest rate. In this way they can extend more credit, that is, they can increase the economy's liquidity and lower the interest rate. As a result, Edge Company will be able to increase its investments as the interest rate is lower, thus increasing dividends and thus the company's share price. On the other hand, investments in equities (variable income) are more favorable, as the fall in interest rates makes investments in fixed income remunerated by interest rates less attractive.

Answer 2

The Federal Government announcing a decrease of the discount rate should improve the situation of Edge Company, given that when the Federal Reserve makes use of this tool it makes it cheaper for commercial banks to borrow money, which results in the increase in available credit and lending activity throughout the economy. This aid provided by the government when it sees the need in the market increases investment activity, thus, elevating the probability of stock prices to raise.