Real interest rate

Question description

According to Saunders and Cornett (2015), “Time value of money is the basic notion that a dollar received today is worth more than a dollar received at some future date” (p. 49). In this assignment, you are expected to demonstrate your understanding of this concept by writing a two to four-page response to the questions presented below.

1.A security’s equilibrium rate of return is 7 percent. For all securities, the inflation risk premium is 1.65 percent and the real interest rate is 3.25 percent. The security’s liquidity risk premium is .25 percent and maturity risk premium is .75 percent. The security has no special covenants.

What is the security’s default risk premium?

  1. You are considering an investment in 30-year bonds issued by Envision Corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 3.25 percent. Your broker has determined the following information about economic activity and Envision Corporation bonds:
    • Real interest rate is 2.20%
    • Default risk premium is 1.00%
    • Liquidity risk premium is 0.50%
    • Maturity risk premium is 1.75%

What is the inflation premium? What is the fair interest rate on Moore Corporation 30-year bonds?

  1. Suppose we observe the following rates: 1R1=.10, 1R2=.16, and E(2r1) = .10

    If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2?

  2. Assume you received $8,000 five years from today. Calculate the present value of the $8,000 if your investments pay the following:
    • 6 percent compounded annually
    • 8 percent compounded annually
    • 10 percent compounded annually
    • 10 percent compounded semiannually
    • 10 percent compounded quarterly

What do your answers tell you about the relation between present values and interest rates and between present values and the number of compounding periods per year?

  1. Assume you received $8,000 today. Calculate the future value in five years of the $8,000 if your investments pay:
    • 6 percent compounded annually
    • 8 percent compounded annually
    • 10 percent compounded annually
    • 10 percent compounded semiannually
    • 10 percent compounded quarterly

What do your answers to these questions tell you about the relation between future values and interest rates and between future values and the number of compounding periods per year?

  1. Assume you just retired and you have accumulated $900,000 in your retirement account. You opted to receive annual payment of $60,000 for the next 30 years.

What is the interest rate on this annuity?

Your response must adhere to the following standards:

  • Be 2-4 pages in length, excluding the title or reference pages.
  • Display work for all calculations.
  • Cite at least 2 sources properly using the textbook and academic references from the CSU-Global library.
  • Format your sources and response according to the CSU-Global Guide to Writing and APA.

Strawberries

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