Question

the Federal Open Market Operation Committee (FOMC) reduced the federal funds target range in two unscheduled meetings in the month of March: first, to 1 to 1.25 percent on March 3, 2020 (Tuesday) and then to 0 to 0.25% on March 15, 2020 (Sunday). The Dow Jones Industrial Average (DJIA) fell by more than 800 points on March 3 and more than 700 points on March 16 following these announcements. In fact, the DJIA fell by more than 7000 points between March 3 and March 23 followed by these monetary policy announcements amid the COVID-19 pandemic. Use the appropriate stock price valuation model to explain the effect of these monetary policy announcements on the stock prices.

Answer 1

At the time of crises the interest rates (fed funds rate) get slashed to encourage spending. So it will prompt investors to move money from the bond market to the equity market, which then starts to rise with the influx of new capital.

Lower interest rates make it more attractive to buy assets such as automotive, housing and it is also very lucarative for businesses to take cheap loans to expand their horizons.

As we also see DJIA coming down drastically would have impacted the whole of the stock market. The PE of the market was lurking around 22-23 which has come down around 40%. PE or Price to earnings ratio tells you how much you are willing to pay for the earning of the company. Let's say Couple months back a company was trading at 25 PE means for every $ in earnings you are willing to pay $25, as pandemic started taking affect the PE has gone down to 15, in other words the stock has gone cheap. If the fundamentals of the company have stayed the same then it is good opportunity to buy because the Govt. is also discouraging us from putting our money into the Bond market by cutting interest rates, rather we are encouraged to put our money into the stock market or to invest into financially sound companies.

Once normalcy starts kicking in, everything will start finding its feet and growth will be there to be seen into the stock market as well and our investments will appreciate in prices, slowly the interest rates will be picking up as well to curb the potential inflation if it is thought to be higher than the target.