1. You need to provide the loan department with the base rate for a loan commitment for this month that can be taken down starting at the beginning of year two. In addition, you need to provide the interest rate charge for a three year loan commitment to a customer (The Packers, Inc.) whose market debt carries AAA credit quality rating. Your economist tells you that the estimate for the real rate of interest is 7%, and the current market default premium for AAA rated companies is 1.4%. What is (A) the base rate for three year loan commitments that can be taken down starting at the beginning of year five, (B) the average expected inflation rate over the period of the three year loan commitment?, and (C) What is the fair market rate today to charge The Packers for the loan commitment?

Treasury Yield Curve

1 year 1.8%

2 year 2%

3 year 2%

4 year 3.8%

5 year 4.6%

6 year 6.3%

7 year 6.3%

Recall:

R = r + ^e + r ( ^e) + default premium + liquidity premium + maturity premium

_nF_n+k = [(1+oRn+k)^n+k/(1+oRn)^n]^(1/k) - 1