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The Impact of Interest Rate on Investment Decision
This chapter explains the background of the study, statement of the problem, objectives of the study, research questions, significance of the study, research hypotheses, scope of the study, limitations of the study and definitions used in the study.
Malawi and Bader (2010) pointed out that investment is considered to be an important factor in economic growth. One of the prospective determinants of the investment level is the interest rate. Adeshina (2017) stated that investment is the current commitment of specific amount of cash into an income yielding asset with the sole aim of deriving future inflow of cash. This will compensate the investor for the time of releasing the fund for the use of another; the changes in interest rate and the purchasing power of money and the uncertainty of future payment (Oluwatusin 2017). Unlike capital, investment is a flow term and not a stock term. This means that capital is measured at a point in time, while investment can only be measure over a period of time. Investment plays a significant and positive role for progress and prosperity of any country. Many countries rely on investment to solve their economic issues such as poverty, unemployment.
Muhammad et al. (2013) stated that investments in different sectors ultimately raise the capital (in other words cause capital formation), this capital can be divided into two broad categories the first is increase in working capital (in short run) which can be shown by increase in business activity and the other is increased in fixed capital (long run effect), which raise the output (production) which later cause increase in the welfare of the economy. Raise in the interest rate increase the cost of capital for the business sector that is invested in the working and business fixed capital. It also increases the cost of holding inventories. A high interest rate might lower investment because it turns out to be extra expensive to have a loan of money, while a raise in income promotes high investment. Still if a firm decides to employ its personal finance in an investment, the interest rate in this stand for an opportunity cost of investing those finances rather than providing out that quantity of money for interest rate.
According to Soyibo and Adekanye (1992), interest rate is the price paid for the use of money, where it is the opportunity cost of borrowing money from a lender. Interest is the reward that accrues to people who provide the fund with which capital goods are bought. On the other hand, interest rate is the charge a borrower pays for the money lend to him for business or other transaction motives. Investors borrow money from banks and other financial institutions. The response of investment expenses changes keenly with interest rate which is at the mind of money-making analysis. Interest rates is the other strong factors that affect financial policies as well as weaker financial payments in guiding principles of investors, it facilitates investment if the high interest rate is applicable on savings. Interest rate influences savings practically all commercial banks commencing macroeconomic theories. The negative influence of higher investment rate inhibits the macroeconomic effect of interest rate policy (Maranga & Nyambane Nyakundi, 2017).
On the other hands, Shumway and Stoffer (2017) also indicated that the changes in interest rates can reflect the basic situation of the operation of macro economy; it also effects all the macroeconomic variables such as GDP, price level, employment rate, international balance of payments, the rate of economic growth, etc. Obviously, the interest rate is an important economic variable that plays an important role in both macro and micro economy activity. Therefore, a change in interest rates is one of the main factors to judge the macroeconomic situation and the interest rate trend analysis is the main method to predict the macroscopic economic situation. The total social savings and investment are closely linked; therefore, the current interest rates affect the investment activities. At the same time, current interest rates also affect the scale of investment in the future by adjusting the savings. If the interest rate rises, bond prices fall, if the interest rate falls, bond prices rise. The influence of interest rate on investment scale is operate as the opportunity cost of investment on total investment, Under the condition of unchanged in investment income, the rising interest rates increase the cost of investment and then inevitably cause lower income investors to withdraw from the area of investment, so that the demand for investment is reduced. However, falling interest rates means that investment costs decline, thereby stimulating investment and the total social investments increase.
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