Economists and business planners often need to make projections of interest rates in order to effectively plan

Question:

Economists and business planners often need to make projections of interest rates in order to effectively plan for the purchase of equipment and other assets. The timing of these investments is a critical part of the firm's financial management and can have a dramatic effect on the firm's profitability. This is particularly important during times of liquidity problems as we have had in the financial markets. As a CFO of a large retail firm that requires significant amounts of seasonal borrowing, you are interested in forecasting the prime rate for the next several months. You think you can get a good prediction for the consumer price index (CPI) and the unemployment rate months ahead, based on other studies and economic forecasts to which you have access. You have decided to use regression analysis to develop a model to predict the prime rate from the CPI and the unemployment rate. The data for monthly interest rate data (prime rate) from the Federal Reserve Board can be found at the FED Web site (www.stls.frb.org/fred/data/irates/mprime) and the employment and CPI information is provided by the U.S. Bureau of Labor Statistics (www.bls.gov/data/home.htm). The data for 24 months from October 2006 through September 2008 is provided below. The CPI data is for all U.S. items (indexed at year 1967); the unemployment rate is for all civilian unemployment.

			CPI for all urban areas
	Prime Rate	CPI	Unemployment Rate
10/1/2006	8.25	604.6	4.4
11/1/2006	8.25	603.6	4.5
12/1/2006	8.25	604.5	4.4
1/1/2007	8.25	606.3	4.6
2/1/2007	8.25	609.6	4.5
3/1/2007	8.25	615.4	4.4
4/1/2007	8.25	619.1	4.5
5/1/2007	8.25	622.9	4.5
6/1/2007	8.25	624.1	4.6
7/1/2007	8.25	624	4.7
8/1/2007	8.25	622.8	4.7
9/1/2007	8.03	624.5	4.7
10/1/2007	7.74	625.9	4.8
11/1/2007	7.50	629.6	4.7
12/1/2007	7.33	629.2	5.0
1/1/2008	6.98	632.3	4.9
2/1/2008	6.00	634.1	4.8
3/1/2008	5.66	639.6	5.1
4/1/2008	5.24	643.5	5.0
5/1/2008	5.00	648.9	5.5
6/1/2008	5.00	655.5	5.5
7/1/2008	5.00	658.9	5.7
8/1/2008	5.00	656.3	6.1
9/1/2008	5.00	655.4	6.1

Required
1. Develop a regression model to predict interest rates using the Bureau of Labor Statistics and Federal Reserve Board data above. Evaluate the results of the regression.
2. Use the model you developed to predict the prime rate for December 2008 if the CPI is expected to be 670 and the unemployment rate is expected to be 6.6 in December.
3. What other economic data can you find on the Web that would help in predicting the prime interest rate? Include the Web links in your answer, if appropriate.
4. To follow up on the regression analysis in part 1, go to the Web sites indicated above, include the most recent data, and rerun the regressions with the same objective of predicting the prime rate for December 2008. Compare your results to the finding for the regression in part 1 and to the actual prime rate in December 2008. Why the difference, ifany?