1. In late 1990, data was released showing inflation was 15%. At the time, the prime rate of interest was 21%, a record high. However, many investors expected the new administration to be more effective in controlling inflation. Moreover, many observers believed that the extremely high-interest rates and generally tight credit, which resulted from the Federal Reserve Systems attempts to curb the inflation rate, would lead to a recession, which, in turn, would lead to a decline in inflation and interest rates. Assume that, at the beginning of 1991, the expected inflation rate for 1991 was 13%; for 1992, 5%; for 1993, 8%; and for 1994 and thereafter, 6%. What was the average expected inflation rate over the 5-year period 19911995? (Use the arithmetic average.)

2.Over the 5-year period, what average nominal interest rate would be expected to produce a 2% real risk-free return on 5-year Treasury securities? Assume Assume 7.6% inflation.

Assume the interest rate on a 1-year T-bond is currently 7% and the rate on a 2-year bond is 8%. If the maturity risk premium is zero, what is a reasonable forecast of the rate on a 1-year bond next year?

3. Describe the general economic conditions that could lead to an upward-sloping yield curve. (MUTIPLE CHOICE)

a. An upward-sloping yield curve occurs in normal times

b. An upward-sloping yield curve occurs in times of recession

c. An upward sloping yield curve occurs during inflation

4. If inflation during the last 12 months was 3% and the interest rate during that period was 7%, what was the real rate of interest?