4-What is the difference in EAR for two investments A and B, if you know that APR is 8% for both of them, and interest is paid annually for A and quarterly for B?We should calculate EAR for both A and B as followsEARA=(1+APRm)m−1=(1+81)1−1=8EARB=(1+APRm)m−1=(1+84)4−1=8.24Then the difference is 0.24%EARB−EARA=8.24−8=0.246.What is the nominal interest rate on an investment that equals $10,000 today and its future value is $28,500 after 10 years, if you know that the interest is paid annually and the expected inflation is 5.5%?The real interest rate isReal Interest Rate=(FVPV)1n−1Real Interest Rate=(2850010000)110−1= 0.11Then we can get the nominal interest rate as followsNominal Interest Rate = Real Interest Rate + Expected Inflation RateNominal Interest Rate = 11%+ 5.5% = 16.5%
8.How can you explain the relationship between nominal interest rate and risk-free rate, and default premium and maturity premium?Risk-free rate is that rate the investor will earn on a loan when the borrower never defaults, like the interest rate on Treasury bills because the government will never default. This risk-free rate, rf, consists of two elements – real interest rate and inflation raterf=r¿+hWhere r¿is the real interest rate and his the inflation rate. However, in the case that the borrower defaults, the investor will be compensated by the default premium, dp. In addition, the investor should be compensated for waiting until fullrepayment has been received, and this is the maturity premium mp. Thus, the nominal interest rate is calculated as the following:r=r¿+h+dp+mp1.Periodic interest rates. In the following table, fill in the
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