On the first day of your summer internship, youve been assigned to work with the Chief Financial

Officer (CFO) of SanBlas Jewels Inc. Not knowing how well trained you are, the CFO has decided

to test your understanding of interest rates. Specifically, she asked you to provide a reasonable estimate

of the nominal interest rate for a new issue of Aaa-rated 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 (2-1) in the text. Your assignment also requires that you consult the data in Table 2-2.

Some agreed-upon procedures related to generating estimates for key variables in equation (2-1)

follow.

a. The current 3-month Treasury bill rate is 2.96 percent, the 30-year Treasury bond rate is

5.43 percent, the 30-year Aaa-rated corporate bond rate is 6.71 percent, and the inflation

rate is 2.33 percent.

b. The real risk-free rate of interest is the difference between the calculated average yield on

3-month Treasury bills and the inflation rate.

c. The default-risk premium is estimated by the difference between the average yield on Aaarated

bonds and 30-year Treasury bonds.

d. The maturity premium is estimated by the difference between the average yield on 30-year

Treasury bonds and 3-month Treasury bills.

e. SanBlas Jewels bonds will be traded on the New York Bond Exchange, so the liquidity premium

will be slight. It will be greater than zero, however, because the secondary market for

the firms bonds is more uncertain than that of some other jewel sellers. It is estimated at 4

basis points. A basis point is one one-hundredth of 1 percent.

Now place your output into the format of equation (2-1) 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.