The current one year interest rate is 0.0430. Economists at Federal Reserve Syst

Question

The current one year interest rate is 0.0430. Economists at Federal Reserve System forecast that one year interest rates expected at t=1,2,3,4 will be following for the next five years

one year rate
t Expected at t liquidity premium
--------------------------------------------------------------*
0 0.0430 0.0000
1 0.0513 0.0020
2 0.0535 0.0020
3 0.0635 0.0025
4 0.0715 0.0030

A. Use the exact expectation theory, forecast the following
The interest rate on a two year loan
The interest rate on a three year loan
The interest rate on a four year loan
The interest rate on a five year loan

B. Suppose that you believe in the liquidity premium theory of Mishikin, what will be the revised interest rates on a two year loan, on a three year loan, on a four year loan, and on a five year loan

C. Suppose that you use the average rather than the geometric mean. What are the rates on the following:
Two year loan
Three year loan
Four year loan
Five year loan







Q3
A.The coupon rate of Erie-Chicago Rail is 7%. The interest rate of Florida municipal bond with equal risk is 6%. At what tax rate the two bonds are as good as each other

B.Suppose that the coupon rate of Eire-Chicago is r and the interest rate of Florida bond is i Let t be the tax rate. What is the formula to calculate the tax rate at which both bonds become precisely as good as each other?



Q4. Assume that you believe in the exact expectation theory.
A.The one year interest rate at t=0 is 0.03 now. The interest rate on the two year loan is 0.035. Calculate the one year interest rate expected(forward rate) at t=1.

B. Suppose further that the interest rate on the three year loan is 0.04. What will be the forecast of the one year interest rate expected(forward rate) at t=2?

C. Suppose futher that the interest rate of the four year loan is 0.043. What will be the forecast of the one year interest rate expected(forward rate) at t=3?

D.Suppose further that the interest rate of the five year loan is 0.045. What will be the
forecast of the one year interest rate expected(forward rate) at t=4?

Q5 Assume that you believe in Mishikin’s version of the liquidity premium theory.
A.The interest rate on the two year loan is 0.085 whereas that on one year loan is 0.08 at t=0. The liquidity premium on one year loan is 0 and the liquidity premium on two year is 0.002.
Calculate the one year interest rate expected(forward rate) at t=1.

B.The interest rate on the three year loan is 0.087. Whereas the interest rate on the two year loan is 0.085 as given in A. Suppose that the liquidity premium at t=1 is 0.002 and that at t=2 is 0.0025.
Calculate the one year interest rate expected (forward rate) at t=2.

C. The interest rate on the four year loan is 0.09. Whereas the interest rate on the three year loan is 0.087 as in B. Suppose that the liquidity premium at t=3 is 0.0028 and that at t=2 is 0.0025 as in B.
Calculate the one year interest rate expected(forward rate) at t=3

D.The interest rate on the five year loan is 0.092. Whereas the interest rate on the four year loan is 0.09 as in C. Suppose that the liquidity premium at t=4 is 0.003 and that
at t=3 is 0.0028 as in C.
Calculate the one year interest rate expected(forward rate) at t=4








rate Liquidity premium
-------------------------------------------------------------------------------*
One year interest rate t=0 0.08 0
on the 2 year loan 0.085 0.002
on the 3 year loan 0.087 0.0025
on the 4 year loan 0.090 0.0028
on the 5 year loan 0.091 0.0030


Q6
A A zero coupon bond matures in 5 years. The market interest for the bond is 10%.
What will be the price of the zero?


B. Suppose that the price of this zero is $700. What is the market interest rate implied here?

Explanation / Answer

Idk

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