An increase in the prevailing interest rate?

Question

a. decreases the present value of future returns from investment and decreases investment.
b. increases the present value of future returns from investment and decreases investment.
c. increases the present value of future returns from investment and increases investment.
d. decreases the present value of future returns from investment and increases investment.

Answer 1

Your answers make no sense. An increase in interest rates, bring a higher rate of return to fixed assets. If rates continue to go higher, markets may tend to go downward, as investors look into safe returns.

Answer 2

It decreases the present value of future cash flows.

As for the second part of the question -- the answer is not cut & dry. Corporations will invest less in their own projects -- since the PV of those flows decreases, turning projects that were positive NPV into projects that are negative NPV. But they may put that money into the bond market instead. So -- their investment just switches from an internal investment to an external investment.

As for investments in general, if the real investment rate goes up, then there will be an increase in investment (people switching from consumption to investment). On the other hand -- if the interest rate goes up because of inflation, then you have an increase in nominal rates, but not in the real rate -- so you wouldn't get the increase in investment.

Whoever asked this question is very sloppy

Answer 3

An increase in the prevailing interest rate will result in money going out of stock investments and money going into fixed return investments. People look for a shorter horizon (present values) and pull money out of future investments.

So the answer is (b) increases in the present value of future returns from investment (the fixed returns) and decreases in investment.