1.

Inflation, nominal interest rates, and real

rates.

From 1991 to 2000, the U.S. economy had an annual inflation rate of around

2.21%.

The historical annual nominal risk-free rate for this same period was around

5.46%.

Using the approximate nominal interest rate equation and the true nominal interest rate equation, compute the real interest rate for that decade.

What is the estimated real interest rate using the approximate nominal interest rate equation for that decade?

nothing%

(Round to two decimal places.)

2.

Interest

premium.

Shaky Company has just issued a five-year bond with a yield of 9%; Stable Company has issued an identical five-year bond, but with a yield of 7%. Why did the market demand a higher return from Shaky?

(Select the best response.)

A.

Companies with poor financials tend to compensate investors for the default risk by issuing bonds with high yields.

B.

Companies with poor financials tend to compensate investors for the liquidity risk by issuing bonds with high yields.

C.

Companies with poor financials tend to compensate investors for the inflation risk by issuing bonds with high yields.

D.

Companies with poor financials tend to compensate investors for the systematic risk by issuing bonds with high yields.

3.

Interest

premium.

Estimate the default premium and the maturity premium given the following three investment opportunities: a Treasury bill with a current interest rate of

3%;

a Treasury bond with a twenty-year maturity and a current interest rate of

4.5%;

and a AAA, corporate bond with a twenty-year maturity and an interest rate of

7%.

What is the default premium?

nothing%

(Round to two decimal places.)