Question

8) Your text argues that investment and the interest rate are negatively correlated, because higher interest rates make borrowing money for investment by a firm from a bank a less attractive option. Firms, in fact, only finance about 20-25% of their new capital by borrowing and the remainder is financed by equity ownership (including reinvesting retained earnings).

Answer 1

Answer - Yes the given statement is correct. The amout of the investment is inversly proportional to the interest rate. At the higher interest rates , the borrowing for the investment becomes expensive. Also , the interest are to be paid regularly without any default which creates a burden upon the firm.

To avoid this high cost and greater interest risk , they tend to focus more on allotingt the equity. Through this , they do not have the obligation to pay after fixed period. They can pay as per the level of profits. They have to repay the principle at the end of business. Thus the risks reduce and hence this becomes more preferred method of borrowing.