Extra Solution on Determination and Term Structure of Interest Rate - CHAPTER 6 The Structure of Interest Rates Answers to End-of-Chapter Questions 1

Extra Solution on Determination and Term Structure of Interest Rate

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CHAPTER 6: The Structure of Interest Rates Answers to End-of-Chapter Questions 1.Using the Federal Reserve Bulletinor the Federal Reserve Bank of St. Louis website (FRED), or The Wall Street Journal, plot the yield curve for U.S. Treasury securities on a quarterly basis for this year. Given your knowledge of the term structure of interest rates, what would be your economic forecast for next year? 2.Summarize the expectation theory and the segmentation theory of the term structure of interest rates. Are these theories in any way related or are they alternative explanationsof the term structure? 3. A commercial bank made a three-year term loan at 10 percent. The bank's economics department forecasts that one and two years in the future, the one-year interest rate will be 10 percent and 14 percent. The current one-year rate is 8 percent. Given that the bank's forecast is reliable, has the bank set the three-year rate correctly? Given the bank's forecast, the three-year rate i 3 (1) should be equal to [(1.08) (1.10) (1.14)] 1/3 -1 = 10.64%. Thus, the bank's loan rate is too low, and it will be deluged with applications. The bank should raise the rate to reflect the market's expectations. 4. Define default risk. How does the default risk premium vary over the business cycle?
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