Explain the popular theories for the rationale of the term structure of interest rates.

You want to invest your savings of $20,000 in government securities for the next 2 years. Currently, you can invest either in a security that pays interest of 8% per year for the next 2 years or in a security that matures in 1 year but pays only 6% interest. If you make the latter choice, you would then reinvest your savings at the end of the first year for another year.

Why might you choose to make the investment in the 1-year security that pays an interest rate of only 6%, as opposed to investing in the 2-year security paying 8%? Provide numerical support for your answer. Which theory of term structure have you supported in your answer?

Explain the impact of inflation on rates of return.

You’re looking at some corporate bonds issued by Ford, and you are trying to determine what the nominal interest rate should be on them. You have determined that the real risk-free interest rate is 3.0%, and this rate is expected to continue on into the future without any change. In addition, inflation is expected to be constant over the future at a rate of 3.0%. The default-risk premium is also expected to remain constant at a rate of 1.5%, and the liquidity-risk premium is very small for Ford bonds, only about 0.02%. The maturity-risk premium is dependent on how many years the bond has to maturity. The maturity-risk premiums are as follows:

Given this information, what should the nominal rate of interest on Ford bonds maturing in 0–1 year, 1–2 years, 2–3 years, and 3–4 years be?

Explain the liquidity preference theory.

You work at the central bank and have been asked to estimate appropriate nominal interest rates for several different Treasury bonds with different maturity dates. You have been told to employ the stable real risk-free interest of 3.5% and steady inflation rate of 2.5%. There is not any default risk or any liquidity risk—there is no liquidity-risk premium. The maturity-risk premiums, dependent upon how many years the bond has to maturity, are as follows:

Based on this information, what should the nominal rate of interest on Treasury bonds maturing in 0–1 year, 1–2 years, 2–3 years, and 3–4 years be?

Explain the term opportunity cost with respect to the cost of funds to the firm.

If the 10-year Treasury bond rate is 4.9%, the inflation premium is 2.1%, and the maturity-risk premium on 10-year Treasury bonds is 0.3%, assuming that there is no liquidity-risk premium on these bonds, what is the real risk-free interest rate?

Identify three distinct ways that savings are ultimately transferred to business firms in need of cash.

Assume 10-year Treasury bonds are yielding of 5%, while a 10-year corporate bond is yielding 7%. If the liquidity-risk premium on the corporate bond is 0.5%, what is the corporate bond’s default-risk premium?

You have been assigned to work as an assistant to the chief financial officer (CFO) of Carat Designs, Inc. As one of your assignments, you have been asked to estimate the nominal interest rate for a new issue of a bond. The final format you should provide to the CFO is that of the equation in the following table.

Some agreed-upon procedures related to generating estimates for key variables are as follows:

• a. The current 3-month Treasury bill rate is 3% and the inflation rate is 2%.
• b. The 30-year Treasury bond rate is 5% and the 30-year corporate bond rate is 7%.
• c. The liquidity-risk premium will be greater than zero, however, because the secondary market for the firm’s bonds is more uncertain. It is estimated at 5 basis points.

Estimate the nominal interest rate and provide a short explanation for every step in the equation for your discussion with the CFO.

Distinguish between the money and capital markets.

The structure of $\mathrm{K}_2\left[\mathrm{PtCl}_6\right]$ in the solid state is shown in the next column. Identify the type of cubic unit cell, and describe the structure in terms of the holes occupied by the various ions.

What is the basic difference between floating and fixed exchange rates?