EBK CORPORATE FINANCE
4th Edition
ISBN: 8220103164535
Author: DeMarzo
Publisher: PEARSON
expand_more
expand_more
format_list_bulleted
Concept explainers
Videos
Textbook Question
Chapter 5, Problem 32P
Suppose the current one-year interest rate is 6%. One year from now, you believe the economy will start to slow and the one-year interest rate will fall to 5%. In two years, you expect the economy to be in the midst of a recession, causing the Federal Reserve to cut interest rates drastically and the one-year interest rate to fall to 2%. The one-year interest rate will then rise to 3% the following year, and continue to rise by 1 % per year until it returns to 6%, where it will remain from then on.
- a. If you were certain regard ng these future interest rate changes, what two-year interest rate would be consistent with these expectations?
- b. What current term structure of interest rates, for terms of 1 to 10 years, would be consistent with these expectations?
- c. Plot the yield curve in this case. How does the one-year interest rate compare to the 10-year interest rate?
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
You borrow $1,000 from a bank at
6% annual interest and promise to
pay it back after a year. As you sign
the loan documents, both you and
the bank expect inflation to be 3% in
the coming year. During the course
of the year, however, the average
price level rises by only 1%. What
best describes this situation?
Select one:
a. Both you and the bank are
better off because the inflation
rate is less than the nominal
interest rate but greater than
zero.
O b. The bank has gained at your
expense because the real
interest rate on the loan is higher
than expected.
c. Neither you nor the bank has
gained anything extra because
the inflation rate is less than the
nominal interest rate.
O d. You have gained at the bank's
expense because you can pay
the bank back in inflated dollars.
Suppose you know that based on the current economic settings, you can purchase 11% more goods next year if you leave your money in the bank. If the expected inflation rate next year is 4%, what is the exact interest rate your bank is quoting you?
The two-year interest rate is 10.4%, and the expected annual inflation rate is 5.2%.
a. What is the expected real interest rate?
b-1. If the expected rate of inflation suddenly rises to 7.2%, what does Fisher's theory say about how the real interest rate will change?
b-2. If the expected rate of inflation suddenly rises to 7.2%, what will be the new nominal rate?
Complete this question by entering your answers in the tabs below.
Req A
Req B1
Req B2
What is the expected real interest rate?
Note: Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.
Expected real interest rate
%
Chapter 5 Solutions
EBK CORPORATE FINANCE
Ch. 5.1 - Prob. 1CCCh. 5.1 - Prob. 2CCCh. 5.2 - How can you compute the outstanding balance on a...Ch. 5.2 - What is an amortizing loan?Ch. 5.3 - What is the difference between a nominal and real...Ch. 5.3 - How do investors expectations of future short-term...Ch. 5.4 - Prob. 1CCCh. 5.4 - How do taxes affect the interest earned on an...Ch. 5.5 - What is the opportunity cost of capital?Ch. 5.5 - Why do different interest rates exist, even in a...
Ch. 5 - Your bank is offering you an account that will pay...Ch. 5 - Which do you prefer: a bank account that pays 5%...Ch. 5 - Prob. 3PCh. 5 - Prob. 4PCh. 5 - You are considering moving your money to a new...Ch. 5 - Prob. 6PCh. 5 - Prob. 7PCh. 5 - You can earn 50 in interest on a 1000 deposit for...Ch. 5 - Prob. 9PCh. 5 - Prob. 10PCh. 5 - Prob. 11PCh. 5 - Prob. 12PCh. 5 - Prob. 13PCh. 5 - Prob. 14PCh. 5 - You have just sold your house for 1,000,000 in...Ch. 5 - Prob. 16PCh. 5 - Your mortgage has 25 years left, and has an APR of...Ch. 5 - Prob. 18PCh. 5 - Prob. 19PCh. 5 - Prob. 20PCh. 5 - Prob. 21PCh. 5 - Prob. 22PCh. 5 - The mortgage on your house is five years old. It...Ch. 5 - You have credit card debt of 25,000 that has an...Ch. 5 - Prob. 25PCh. 5 - Prob. 26PCh. 5 - Prob. 27PCh. 5 - Prob. 28PCh. 5 - Suppose the term structure of risk-free interest...Ch. 5 - Prob. 30PCh. 5 - Prob. 31PCh. 5 - Suppose the current one-year interest rate is 6%....Ch. 5 - Figure 5.4 shows that Johnson and Johnsons...Ch. 5 - Prob. 34PCh. 5 - Prob. 35PCh. 5 - Prob. 36PCh. 5 - Your best friend consults you for investment...Ch. 5 - Suppose you have outstanding debt with an 8%...Ch. 5 - In the summer of 2008, at Heathrow Airport in...Ch. 5 - Your firm is considering the purchase of a new...Ch. 5 - Prob. 41P
Additional Business Textbook Solutions
Find more solutions based on key concepts
(Capital asset pricing model) Using the CAPM, estimate the appropriate required rate of return for the three st...
Foundations of Finance (9th Edition) (Pearson Series in Finance)
Define investors’ expected rate of return.
Foundations Of Finance
The call option price. Option: The options are the financial statements that provides its holders an opportunit...
Gitman: Principl Manageri Finance_15 (15th Edition) (What's New in Finance)
The characteristic and terms of a single-payment note and the way in which an effective annual rate on this not...
Principles of Managerial Finance (14th Edition) (Pearson Series in Finance)
Budgeted manufacturing overhead rate, allocated manufacturing overhead. Taylor Company uses normal costing. It ...
Horngren's Cost Accounting: A Managerial Emphasis (16th Edition)
E5-18 Using accounting vocabulary
Learning Objectives 1, 2,3
Match the accounting terms with the corresponding ...
Horngren's Accounting (11th Edition)
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Inflation is expected to average 2.4% per year for the next 44 years. What percentage of the purchasing power of the dollar will be lost?arrow_forwardA person wants to withdraw PLN 5,000 a quarter for 36 years. This person also 4) wishes to index this amount by about 0.075% per quarter to compensate for inflation effects. How much should he have today to achieve this goal if the average nominal interest rate for instruments he wants to use for saving generates a return of 5,5% per year?arrow_forwardMicrosoft corporation wants to reduce its interest rate exposure and will need to borrow $1,000,000 in six months' time for a 6-month period. The interest rate at which it can borrow today is 6-month LIBOR plus 0.5 percent. Let us further assume that the 6-month LIBOR currently is at 0.89465%, but the company’s treasurer thinks it might rise as high as 1.30% over the forthcoming months.The treasurer choses to buy a 6x12 FRA in order to cover the period of 6 months starting 6 months from now. He receives a quote of 0.95450% from his bank and buys the FRA for 1,000,000 $ on April 8th.Characteristics of the FRA known on trade date:Trade date 08/04/2019Spot date (t+2) 12/04/2019Fixing date 10/10/2019Settlement date 12/10/2019Maturity date 12/04/2020 Contract period: 182 daysFRA rate 0.95450% On the fixing date (October 10th, 2019), the 6-month LIBOR fixes at 1.26222, which is the settlement rate applicable for the company's FRA. a) Calculate and interpret the interest differential, did the…arrow_forward
- Microsoft corporation wants to reduce its interest rate exposure and will need to borrow $1,000,000 in six months' time for a 6-month period. The interest rate at which it can borrow today is 6-month LIBOR plus 0.5 percent. Let us further assume that the 6-month LIBOR currently is at 0.89465%, but the company's treasurer thinks it might rise as high as 1.30% over the forthcoming months. The treasurer choses to buy a 6x12 FRA in order to cover the period of 6 months starting 6 months from now. He receives a quote of 0.954509% from his bank and buys the FRA for 1,000,000 S on April 8th. Characteristics of the FRA known on trade date: Trade date 08/04/2019 Spot date (t+2) 12/04/2019 Fixing date 10/10/2019 Settlement date 12/10/2019 Maturity date 12/04/2020 Contract period: 182 days FRA rate 0.95450% On the fixing date (October 10th, 2019), the 6-month LIBOR fixes at 1.26222, which is the settlement rate applicable for the company's FRA. a) Calculate and interpret the interest…arrow_forwardSuppose the interest rate on a 3-year Treasury Note is 1.25%, and 5-year Notes are yielding a 3.50%. Based on the expectations theory, what does the market believe that 2 year treasuries will be yielding 3 years from now?arrow_forwardBecause of a recession, the inflation rate expected for the coming year is only 3% .However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3%. Assume that the real risk-free rate is r* = 2% for all maturities and that there are no maturity premiums. If 3-year Treasury notes yield 2 percentage points more than I-year notes, what inflation rate is expected after Year 1?arrow_forward
- . Inflation is expected to average 2.4% per year for the next 44 years. How much money will be required, 44 years from now, to buy the same amount of goods and services as $1 does today?arrow_forwardYour father now has $1,000,000 invested in an account that pays 9.00%. He expects inflation to average 3%, and he wants to make annual constant dollar (real) end-of-year withdrawals over each of the next 20 years and end up with a zero balance after the 20th year. How large will his initial withdrawal (and thus constant dollar [real] withdrawals) be?arrow_forwardYou are considering investing money in Treasury bills and wondering what the real risk-free rate of interest is. Currently, Treasury bills are yielding 4.3% and the future inflation rate is expected to be 2.5% per year. Ignoring the cross product between the real rate of interest and the inflation rate, what is the real risk-free rate of interest?arrow_forward
- John Ayena, a trainee at an investment banking firm, is trying to get an idea of what real rate of return investors are expecting in today’s marketplace. He has looked up the rate paid on 3-month U.S. Treasury bills and found it to be 5.5%. He has decided to use the rate of change in the Consumer Price Index as a proxy for the inflationary expectations of investors. That annualized rate now stands at 3%. On the basis of the information that John has collected, what estimate can he make of the real rate of return?arrow_forwardSuppose that North bank currently charges a 3.5% fixed interest rate on a six -year auto loan and pays a 2.5% interest rate to customers who buy 6-month CDs. Suppose that at the end of the six-month period depositors roll over the funds in the CD for another six months. Then the interest rate spread is ? Suppose now that market interest rates increase by 0.4%. This means that North bank has to pay a (Higher, lower, the same) interest rate on CDs when they mature, while charging (Higher, lower, the same) interest rate on the six -year auto loans. What will happen to the interest rate spread? (choose 1) It decreases to 0.6% and the North bank's interest income rises. It becomes equal to 2.9% and the North bank's interest income rises. It increases to 2.5% and the North bank's interest income falls. It decreases to 0.6% and the North bank's interest income falls.arrow_forwardIn recent years, the United States has gone from being a “positive savings” notion to a “negative savings” notion (i.e. Americans spend more money than they earn). Suppose a typical American household spends $10,000 more than it makes and it does this for eight consecutive years. If this debt will be financed at an interest rate of 15% per year, what annual repayment will be required to repay the debt over a 10 year period (repayments will start at EOY 9)?arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Essentials Of InvestmentsFinanceISBN:9781260013924Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.Publisher:Mcgraw-hill Education,
Foundations Of FinanceFinanceISBN:9780134897264Author:KEOWN, Arthur J., Martin, John D., PETTY, J. WilliamPublisher:Pearson,
Fundamentals of Financial Management (MindTap Cou...FinanceISBN:9781337395250Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i...FinanceISBN:9780077861759Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan ProfessorPublisher:McGraw-Hill Education
Essentials Of Investments
Finance
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:9780134897264
Author:KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:Pearson,
Fundamentals of Financial Management (MindTap Cou...
Finance
ISBN:9781337395250
Author:Eugene F. Brigham, Joel F. Houston
Publisher:Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i...
Finance
ISBN:9780077861759
Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:McGraw-Hill Education
Monetary Policy explained; Author: Sim Institute;https://www.youtube.com/watch?v=IMkLAP_aj3I;License: Standard Youtube License