What would happen to the interest rates when investors prefer equity investment to bond/debt investment? If more and more investors invest in equity, funds flow to stock market rather than to the bond market or commercial banks. People will buy shares by paying more and thus is expected to get a lower amount of dividend yield. But my concern is not that. When funds are withdrawn from the debt market, there is an immediate shortage of funds in that market which will trigger an increase in the interest rate as long as the credit is demanded as it is. But can we expect this to happen? As soon as the people who need/demand credit get to know that people prefer equity investment to debt/bond investment, they will go for higher equity financing rather than debt financing. This will surely happe n because tax savings from debt financing will get a bit risky because of a higher cost of debt (higher interest) and a higher likelihood of bankruptcy cost and all that, according to Modigliani and Miller proposition. And as tax savings get risky, valuation models are supposed to work in a neutral manner (meaning higher tax savings due to higher cost of debt is discounted by a higher required rate of return due to higher risk). So, my question is, there would not be any increase in the interest rate after a while because equity financing will be more preferable and demand for credit goes down. The supply and demand curve of credit each shifts and the effect in interest should be neutral (at least approximately), right?
I think yields will increase to a point. If the equity market is booming, it probably makes more sense to raise capital via equities at a higher offering price.