Financial Markets and Institutions: Chapter 3

1. Forward Rate 2 percent today, 4 percent one year from now, and a. Assume that, as of today, the annualized two-year 6 percent two years from now. Using only pure interest rate is 13 percent and the one-year interest expectations theory, what are the current interest rate is 12 percent. Use this information to estimate the rates on two-year and three-year securities? one-year forward rate. 6. Commercial Paper Yield b. Assume that the liquidity premium on a two-year a. A corporation is planning to sell its 90-day com- security is 0.3 percent. Use this information to mercial paper to investors by offering an 8.4 percent estimate the one-year forward rate. yield. If the three-month T-bill's annualized rate is 2. Forward Rate Assume that, as of today, the 7 percent, the default risk premium is estimated to be annualized interest rate on a three-year security is 0.6 percent, and there is a 0.4 percent tax adjustment, 10 percent and the annualized interest rate on a two- then what is the appropriate liquidity premium? year security is 7 percent. Use this information to b. Suppose that, because of unexpected changes in estimate the one-year forward rate two years from now. the economy, the default risk premium increases to 3. Forward Rate If > 2, what is the market 0.8 percent. Assuming that no other changes occur, consensus forecast about the one-year forward rate one what is the appropriate yield to be offered on the year from now? Is this rate above or below today's one- commercial paper? year interest rate? Explain. 7. Forward Rate 4. After-Tax Yield You need to choose between a. Determine the forward rate for various one-year investing in a one-year municipal bond with a 7 percent interest rate scenarios if the two-year interest rate is yield and a one-year corporate bond with an 11 percent 8 percent, assuming no liquidity premium. Explain the yield. If your marginal federal income tax rate is relationship between the one-year interest rate and 30 percent and no other differences exist between the one-year forward rate while holding the two-year these two securities, which would you invest in? interest rate constant 5. Deriving Current Interest Rates Assume that b. Determine the one-year forward rate for the same interest rates for one-year securities are expected to be one-year interest rate scenarios described in