What is the effect of an interest rate cut upon corporations

Interest rates were cut in America by the Federal Reserve on the 22nd January 2008 by 0. 75%, the biggest single change in interest rates since 1994.

The reason for this interest rate cut was due to disastrous economic conditions, caused by the sub-prime mortgage market collapsing. The market collapsed, causing huge losses for many banks and investment banks, in particular banks such as Northern Rock. Northern Rock then had to be bailed out by the treasury, as to prevent most banks from collapsing, as banks lend to each other, so if one bank collapsed (Northern Rock in this instance) many more would follow in a domino effect.Similar fears around the banking industry were held in the USA. The inherent problem was that banks were issuing mortgages to people with bad credit ratings, 5 to 6 times the salary of the person they are lending to. There was no real way that they could actually reclaim this money, as the people would be unable to keep up with their mortgage repayments.

This sparked huge losses within this industry, with banks that had lots of money lent to the banks who had issued these mortgages, Northern Rock being a bank with money stored up in this market, lost out when the market collapsed and many banks lost billions of dollars.Share indexes fell, with stock prices tumbling due to the huge losses made by banks, drying up investment from these banks, sparking fears of market recession coming from the downturn caused by the collapse of the sub-prime mortgage market. The reason that the interest rates were cut, was to decrease the amount of interest payable on loans, increasing disposable incomes for most, attempting to boost the economy with spending. However, the dollar is weakened against most currencies as a result of this, as less is now more, with interest rates cut saving in the USA is less attractive and money would be moved out of America to other places.It also has a rather large effect upon companies, but how exactly would multinational companies be affected by this? The cost of importing goods and raw materials into the USA would be more expensive, affecting businesses based in that area, but what about the companies based all across the world, what would be the effect upon them? One initial effect that was felt by every single multinational (with very few exceptions) was tumbling value of shares in the company.

The impact of this would be that the company in itself is valued less; the people who have invested into the company have lost a lot of their money, as the amount that they bought the shares for is a lot less than what it was when they bought it. However, the interest rate cut in itself has slowed the falling prices of shares, by allowing people to have more ability to pay back loans to banks who then in turn can invest the money in other things; these other things may include expanding their share portfolio by buying into multinational companies, this would be a good thing.One problem would be for multinational companies, who are based away from the USA, but export heavily to it. The reason why this would be problematic is because the dollar has fallen in comparison to most currencies, including the Euro and the Pound.

It being weakened, means that for the dollar a US firm budgets for, they have to pay more when paying in pounds as the worth of a dollar in comparison to a pound has changed.For example, Vivomed exports sports medicine to the USA, because of the decrease in value of the dollar; they would have to either reduce prices of their product in order to maintain the same price in dollars, meaning that there is a lower mark-up with less profit made, or they would have to risk keeping the price in pounds converted to dollars the same, so an increase in the price in dollars which could possibly scare away possible consumers resulting in a surplus of stock, which would be even worse than lower profit margins as they are not even selling the product enough to make any profit.However, the products that they sell in the UK would remain the same as ever, so not even that would compensate the slow in US buying. Multi-national companies that produce a majority of their products in the US, but export to the rest of the world would be boosted by a weak dollar; the people who wish to buy who are abroad would, due to an advantage in that it would be fairly cheap in comparison to exchange rates where the dollar is not as weak.

An example of a company like this would be Gensler, who export services abroad and at home in designing all sorts of things, from shopping complexes to cities. However, a big advantage of multinational companies is that they can theoretically base themselves anywhere in the world to take advantage of favourable situations, such as favourable currency rates or countries where wages are not as high as in other countries, decreasing costs and therefore increasing profit.The effect that the sub-prime mortgage markets collapse and the subsequent cut in interest rates, is that of the US market being tentative to import products due to a decrease in the value of the dollar, this is something that will have an adverse effect on most multinational companies, despite the fact that they are usually mainly unaffected by currency exchange rate change, the dollar's drastic weakening will sabotage a large amount of some of their sales market.They may still be able to sell the products, but the profit margin upon it will be less than it would've been before, resulting in lower profits for multinational corporations on the whole.