In equity markets with limited arbitrage, liquidity also matters. Liquidity denotes the ability to trade in large quantities quickly, at low cost and without moving the price. Because the prices of long-term securities are more sensitive to interest rate movements. Therefore investors will be willing to hold them only if compensated with a premium for the lower degree of liquidity.
Stocks, also referred to as equity securities, have no maturity and therefore serve as a long-term source of funds. Equity securities differ from debt securities in that they represent partial ownership. Investors can earn a return from stocks in the form of periodic dividends and a capital gain when they sell the stock.
Interest rate movements have a direct influence on the market values of debt securities, such as money market securities (Treasury bills, CDs, Commercial Paper, Federal funds, Repurchase Agreements), bonds, and mortgages (capital market securities), and have an indirect influence on equity security (stock) values.
Loanable Funds Theory - net demand for funds (ND) is the difference of the aggregate demand for funds (D) and the aggregate supply of funds (S).
ND = D - S > 0, interest rate rise; < 0, interest rate fall.
D = Dh + Db + Dg + Df ; S = Sh + Sb + Sg + Sf
where,
h = household demand/supply of for/of loanable funds
b = business demand/supply of for/of loanable funds
g = government demand/supply of for/of loanable funds
f = foreign demand/supply of for/of loanable funds
