A firm's level of investment is tied to the interest rate
A) only when the firm has to borrow funds to buy capital
B) only when the firm has to borrow funds to buy stocks
C) only when the firm already has the funds and could lend them
D) because the interest rate represents the opportunity cost of investing in capital
E) because investments are always made with borrowed funds

Question

Quizplus · Accepted Answer

The interest rate represents the opportunity cost of investing in capital, meaning that when the interest rate is high, the opportunity cost of investing in capital increases, so the firm may choose to invest less. This relationship holds true regardless of whether the firm has to borrow or has already saved the funds to invest. B, C, and E are incorrect because they are either irrelevant (B and E) or assume that the firm must borrow in order to invest (C). A is incorrect because the relationship between investment and interest rate is not limited to cases where the firm has to borrow in order to invest, although it is certainly relevant in those cases.

A Firm's Level of Investment Is Tied to the Interest