Interest and Real Rate Essay

1763 Words Jan 14th, 2013 8 Pages
P6–1 Interest rate fundamentals: The real rate of return Carl Foster, 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 Carl has collected, what estimate can he make of the real rate of return?

P6–2 Real rate of interest To estimate the real rate of interest, the economics division of Mountain Banks—a major bank holding company—has gathered the
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(Note: Assume that the risk that future interest rate movements will affect longer maturities more than shorter maturities is zero; that is, there is no m summarized in the following table. aturity risk.) These data are summarized in the following table.

U.S. Treasury Nominal rate Inflationary security Point in time Maturity of interest expectation

A Jan. 7 2 years 12.6% 9.5%
B Mar. 12 10 years 11.2 8.2
C May 30 6 months 13.0 10.0
D Aug. 15 20 years 11.0 8.1
E Dec. 30 5 years 11.4 8.3

a. Using the preceding data, find the real rate of interest at each point in time.

b. Describe the behavior of the real rate of interest over the year. What forces might be responsible for such behavior?

c. Draw the yield curve associated with these data, assuming that the nominal rates were measured at the same point in time.

d. Describe the resulting yield curve in part c, and explain the general expectations embodied in it.

P6–7 Term structure of interest rates The following yield data for a number of highestquality corporate bonds existed at each of the three points in time noted.

Time to maturity (years) 5 years ago 2 years ago Today
1 9.1% 14.6% 9.3%
3 9.2 12.8 9.8
5 9.3 12.2 10.9
10 9.5 10.9

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