Describe how interest rates may adjust to an unanticipated increase

Discussion Question 8-2


Describe how interest rates may adjust to an unanticipated increase in inflation.


Assume investors expect a 2.0 percent real rate of return over the next year.  If inflation is expected to be 0.5 percent, what is the expected nominal interest rate for a one-year U.S. Treasury security?


A one-year U.S. Treasury security has a nominal interest rate of 2.25 percent.  If the expected real rate of interest is 1.50 percent, what is the expected annual inflation rate?


Inflation is expected to be 3 percent over the next year. You desire an annual real rate of return of 2.5 percent on your investments.

a.       What nominal rate of interest would have to be offered on a one-year Treasury security for you to consider making an investment?

b.      A one-year corporate debt security is being offered at 2 percentage points over the one-year Treasury security rate that meets your requirement in (a). What would be the nominal interest rate on the corporate security?


Find the nominal interest rate for a debt security given the following information: real rate = 2%, liquidity premium = 2%, default risk premium = 4%, maturity risk premium= 3%, and the inflation premium = 3%.

Discussion Question 9-2

Briefly describe what is meant by the time value of money.


Determine the future values (FVs) if $5,000 is invested in each of the following situations:

 a. 5 percent for ten years

b. 7 percent for seven years

c. 9 percent for four years


a.       What is the present value (PV) of $359,000 that is to be received at the end of 23 years if the discount rate is 11 percent?                                                                                                                                               b.  How would your answer change in Part (a) if the $359,000 is to be received at the end of 20 years?


a.  What would be the future value (FV) of $19,378 invested now if the money remains deposited for eight years, the annual interest rate is 18 percent, and interest on the investment is compounded semiannually?

b.   How would your answer for (a) change if quarterly compounding were used?


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