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On the first day of your summer internship, you've been assigned to work with the Chief Financial Officer ( CFO ) of SanBlas Jewels Inc.
On the first day of your summer internship, you've been assigned to work with the Chief Financial OfficerCFO of SanBlas Jewels Inc. Not knowing how well trained you are, the CFO has decided to test your understanding of interest rates. Specifically, she asks you to provide a reasonable estimate of the nominal interest rate for a new issue of AAArated bonds to be offered by SanBlas Jewels Inc. The final format that the chief financial officer of SanBlas Jewels has requested is that of equation in the text:
Nominal interest rate equals Start By Matrix st Row st Column real risk dash free interest rate plus inflation premium plus default dash risk premium nd Row st Column plus maturity dash risk premium plus liquidity dash risk premium EndMatrixNominal interest rate real riskfree interest rateinflation premiumdefaultrisk premium maturityrisk premiumliquidityrisk premium
Some agreedupon procedures related to generating estimates for key variables in equation follow.
a The currentmonth Treasury bill rate is percent theyear Treasury bond rate is percent theyear AAArated corporate bond rate is percent and the inflation rate is percent.
b The real riskfree rate of interest is the difference between the calculated average yield onmonth Treasury bills and the inflation rate.
c The defaultrisk premium is estimated by the difference between the average yields on AAArated bonds andyear Treasury bonds.
d The maturityrisk premium is estimated by the difference between the average yields onyear Treasury bonds andmonth Treasury bills.
e SanBlas Jewels' bonds will be traded on the New York Bond Exchange, so the liquidityrisk premium will be slight. It will be greater than zero, however, because the secondary market for the firm's bonds is more uncertain than that of some other jewelry sellers. It is estimated at basis points. A basis point is one onehundredth of percent.
Now place your output into the format of equation so that the nominal interest rate can be estimated and the size of each variable can also be inspected for reasonableness and discussion with the CFO. round two decimal points
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