Exam 2: Determinants of Interest Rates

The one-year spot rate is currently 4 percent; the one-year spot rate one year from now will be 3 percent; and the one-year spot rate two years from now will be 6 percent. Under the unbiased expectations theory,what must today's three-year spot rate be? Suppose the three-year spot rate is actually 3.75 percent,how could you take advantage of this? Explain.

Explain the market segmentation theory of the term structure.

In October 1987 stock prices fell 22 percent in one day and bond rates fell also. Use the loanable funds theory to explain what happened.

An investor requires a 3 percent increase in purchasing power in order to induce her to lend. She expects inflation to be 2 percent next year. The nominal rate she must charge is about

You want to have $5 million when you retire in 40 years. You believe you can earn 9 percent per year on your investment. How much must you invest each year to achieve your goal when you retire? (Ignore all taxes.)

Which of the following would normally be expected to result in an increase in the supply of funds,all else equal? I. The perceived riskiness of all investments decreases. II. Expected inflation increases. III. Current income and wealth levels increase. IV. Near term spending needs of households increase as energy costs rise.

Convertible bonds will normally have lower promised yields than straight bonds of similar terms and quality.

The term structure of interest rates is the relationship between interest rates on bonds similar in terms except for maturity.

Explain the logic of the liquidity premium theory of the term structure.

With a zero interest rate both the present value and the future value of an N payment annuity would equal N × payment.

The traditional liquidity premium theory states that long-term interest rates are greater than the average of expected future interest rates.

Inflation causes the demand curve for loanable funds to shift to the _____ and causes the supply curve to shift to the _____.

Would you expect the demand curve for businesses to be steeper than the demand curve for funds by the federal government? Explain.

You buy a car for $38,000. You agree to a 60-month loan with a monthly interest rate of 0.55 percent. What is your required monthly payment?

A 15-payment annual annuity has its first payment in nine years. If the payment amount is $1,400 and the interest rate is 7 percent,what is the most you should be willing to pay today for this investment?

Classify each of the following in terms of their effect on interest rates (increase or decrease): I. Perceived risk of financial securities increases. II. Near term spending needs decrease. III. Future profitability of real investments increases.

The unbiased expectations hypothesis of the term structure posits that long-term interest rates are unrelated to expected future short-term rates.

YIELD CURVE FOR ZERO COUPON BONDS RATED AA Assume that there are no liquidity premiums. To the nearest basis point,what is the expected interest rate on a four-year maturity AA zero coupon bond purchased six years from today?

An increase in the marginal tax rates for all U.S. taxpayers would probably result in reduced supply of funds by households.

According to the unbiased expectations theory,