Exam 2: Determinants of Interest Rates

What is the difference between the expected real interest rate and the real risk-free interest rate actually earned?

When the quantity of a financial security supplied or demanded changes at every given interest rate in response to a change in a factor,this causes a shift in the supply or demand curve.

Suppose that the current one-year Treasury-bill rate is 3.15 percent and the expected one-year rate 12 months from now is 4.25 percent. According to the unbiased expectations theory,what should be the current rate for a two-year Treasury security?

Earning a 5 percent interest rate with annual compounding is better than earning a 4.95 percent interest rate with semiannual compounding.

If you earn 0.5 percent a month in your bank account,this would be the same as earning a 6 percent annual interest rate with annual compounding.

A foreign investor placing money in dollar-denominated assets desires a 4 percent real rate of return. Global inflation is running about 3 percent,and the dollar is expected to decline against her home currency by 1.5 percent over the investment period. What is her minimum required rate of return? Explain.

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

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

According to the unbiased expectations theory,

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?

Simple interest calculations assume that interest earned is never reinvested.

Suppose you borrow $15,000 and then repay the loan by making 12 monthly payments of $1,297.92 each. What rate will you be quoted on the loan?

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

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.)

An investor wants to be able to buy 4 percent more goods and services in the future in order to induce her to invest today. During the investment period prices are expected to rise by 2 percent. Which statement(s)below is/are true? I. 4 percent is the desired real risk-free interest rate. II. 6 percent is the approximate nominal rate of interest required. III. 2 percent is the expected inflation rate over the period.

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.

YIELD CURVE FOR ZERO COUPON BONDS RATED AA Assume that there are no liquidity premiums. You just bought a 15-year maturity Xerox corporate bond rated AA with a 0 percent coupon. You expect to sell the bond in eight years. Find the expected interest rate at the time of sale (watch out for rounding error).

The term structure of interest rates is upward sloping for all bond types. A certain AAA-rated non-callable 10-year corporate bond has been issued at a 6.15 percent promised yield. Which one of the following bonds probably has a higher promised yield?

Upon graduating from college this year,you expect to earn $25,000 per year. If you get your MBA,in one year you can expect to start at $35,000 per year. Over the year,inflation is expected to be 5 percent. In today's dollars,how much additional (less)money will you make from getting your MBA (to the nearest dollar)in your first year?

A higher level of wealth causes the demand for loanable funds to increase and interest rates to fall.