Question

How is this change going to affect stock prices?

The 3-month bill rate in Saudi Arabia in 2018:

`1/2/2017 = 0.86

The change since 2017:

12/24/2018 = 2.6359

Answer 1

The 3-month bill rate has increased over the period and the increase is significant. When such a high return is available for the risk-free investment, it is obvious that some of the funds move from equity to bills. The sell-off in equity causes the stock prices to go down.

In another way, since the risk-free rate has increased, this increases the cost of equity. Note that the risk-free rate is one of the components of CAPM. This causes the cost of equity to go up, which means the stock is perceived to be a higher risk asset. So, to compensate for the higher risk, the investors demand a higher return. The higher return comes from decreased stock prices.

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