Question
7. Forward Rate a. Determine the forward rate for various one year interest rate scenarios if the two year interest rate is 8 percent, assuming
7. Forward Rate a. Determine the forward rate for various one year interest rate scenarios if the two year interest rate is 8 percent, assuming no liquidity premium. Explain the relationship between the one year interest rate and the one year forward rate while holding the two year interest rate constant. b. Determine the one year forward rate for the same one year interest rate sceneries described in question (a) while assuming a liquidity premium of 0.4 percent. Does the relationship between the one year interest rate and the forward rate change when considering the liquidity premium is considered? c. Determine how the one year forward rate would be affected if the quoted one year interest rate rises; hold constant the quoted one year interest rate as well as the liquidity premium. Explain the logic of this relationship. d. determine how the one year forward rate would be affected if the liquidity premium rises and if the quoted one year interest rate is held constant. What if the quoted two year interest rate is held constant? Explain the logic of this relationship. 9. Debt Security Yield a. Determine how the appropriate yield to be offered on a security is affected by a higher risk-free rate. Explain the logic of this relationship. b. Determine how the appropriate yield to be offered on a security is affected by a higher default risk premium. Explain the logic of this relationship.
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