2. Your bank is offering you an account that will pay

25 %25%

interest (an effective two-year rate) in total for a two-year deposit. Determine the equivalent discount rate for the following periods:

a. Six months

b. One year

c. One month

(Note: Be careful not to round any intermediate steps less than six decimal places.)

a. Six months

The equivalent discount rate for a period length of six months is

%.

(Round to two decimal places.)

b. One year

The equivalent discount rate for a period length of one year is

%.

(Round to two decimal places.)

c. One month

The equivalent discount rate for a period length of one month is

%.

(Round to three decimal places.)

3. You have found three investment choices for a one-year deposit:

11.1 %APR compounded monthly,

11.1 %

APR compounded annually, and

10.4 %

APR compounded daily. Compute the EAR for each investment choice. (Assume that there are 365 days in the year.) (Note: Be careful not to round any intermediate steps less than six decimal places.)

The EAR for the first investment choice is

%.

(Round to three decimal places.)

The EAR for the second investment choice is

%.

(Round to three decimal places.)

The EAR for the third investment choice is

%.

(Round to three decimal places.)

4. What is the shape of the yield curve given in the following term structure? What expectations are investors likely to have about future interest rates?

Term

1 year

2 years

3 years

5 years

7 years

10 years

20 years

Rate (EAR, %)

2.012.01

2.382.38

2.752.75

3.313.31

3.773.77

4.154.15

4.954.95

What is the shape of the yield curve given the term structure?(Select the best choice below.)

A.

The yield curve is a flat yield curve.

B.

The yield curve is an inverted yield curve (decreasing).

C.

The yield curve is a normal yield curve (increasing).

D.

It is hard to tell because we are not given an EAR for every year.

What expectations are investors likely to have about future interest rates?(Select the best choice below.)

A.

Interest rates will likely stay the same in the future.

B.

The yield curve provides no clues as to future interest rate levels.

C.

Interest rates might rise in the future.

D.

Interest rates might decrease in the future.