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Some characteristics of the determinants of nominal interest rates are listed as follows. Identify the components (determinants) and the symbols associated with each characteristic: Symbol
Some characteristics of the determinants of nominal interest rates are listed as follows. Identify the components (determinants) and the symbols associated with each characteristic: Symbol Component Liquidity risk premium Real risk-free rate Nominal risk-free rate Characteristic This is the rate on a Treasury bill or a Treasury bond. This is the difference between the interest rate on a US Treasury bond and a corporate bond of the same profile-that is, the same maturity and marketability. As interest rates rise, bond prices fall, and as interest rates fall, bond prices rise. Because interest rate changes are uncertain, this premium is added as a compensation for this uncertainty. This is the premium added to the real risk-free rate to compensate for a decrease in purchasing power over time. This is the rate for a short-term riskless security when inflation is expected to be zero. This premium is added when a security lacks marketability, because it cannot be bought and sold quickly without losing value. Default risk premium Liquidity risk premium Inflation premium Maturity risk premium Symbol Component Liquidity risk premium Characteristic This is the rate on a Treasury bill or a Treasury bond. This is the difference between the interest rate on a US Treasury bond and a corporate bond of the same profile-that is, the same maturity and marketability. As interest rates rise, bond prices fall, and as interest rates fall, bond prices rise. Because interest rate changes are uncertain, this premium is added as a compensation for this TRF MRP uncertainty. This is the premium added to the real risk-free rate to compensate for a decrease in purchasing power over time. This is the rate for a short-term riskless security when inflation is expected to be zero. DRP This premium is added when a security lacks marketability, because it cannot be bought and sold quickly without losing value
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