FIC 3000

FIN3000-005 Assignment

Read Chapter 6 as well as the provided weblinked material, and follow the below instructions.

https://www.federalreserve.gov/faqs/money_12856.htm

http://www.bankrate.com/finance/mortgages/fed-affects-banks-rates-prices-and-jobs-1.aspx

https://www.lendingtree.com/mortgage/affect-of-fed-on-interest-rates-article

1. Define the following. (Short answers okay)

1. 1. Opportunity Cost

   2. Risk Free Rate

   3. Inflation Premium

   4. Default Risk Premium

1. Write an essay of no more than 1 page, that summarizes the role of the Federal Reserve Bank in setting interest rates.

1. Work the following Problems.

   1. Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.

1. 1. Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 2.20%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

1. 1. Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield 6.75%. Also, corporate bonds have a 0.25% liquidity premium versus a zero liquidity premium for T-bonds, and the maturity risk premium on both Treasury and corporate 10-year bonds is 1.15%. What is the default risk premium on corporate bonds?

1. 1. Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 2.25%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.