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## 19 Sep 6-2 Determinants of Interest Rates for Individual

6-2 Determinants of Interest Rates for Individual Securities You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 1.25 percent. Your broker has determined the following information about economic activity and MooreCorporation bonds:Real interest rate 0.75% =Default risk premium 1.15%=Liquidity risk premium 0.50% =Maturity risk premium 1.75% =a. What is the inflation premium? (LG4) =b. What is the fair interest rate on Moore Corporation 30-year bonds? (LG4) =6-5 Unbiased Expectations Theory Suppose that the current 1-year rate (1-year spot rate) and expected 1-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows:1R1= 6%, E( 2r1) = 7%, E(3r1) = 7.5%, E(4r1) = 7.85%Using the unbiased expectations theory, calculate the current (long-term) rates for 1-, 2-, 3-, and 4-year-maturity Treasury securities. Plot the resulting yield curve. (LG5)6-7 Liquidity Premium Hypothesis One-year Treasury bills currently earn 3.45 percent. You expect that one year from now, 1-year Treasury bill rates will increase to 3.65 percent. The liquidity premium on 2-year securities is 0.05 percent. If the liquidity theory is correct, what should the current rate be on 2-year Treasury securities? (LG5)9-25 Portfolio Return At the beginning of the month, you owned \$5,500 of General Dynamics, \$7,500 of Starbucks, and \$8,000 of Nike. The monthly returns for General Dynamics, Starbucks, and Nike were 6.80 percent, 2 1.36 percent, and 2 0.54 percent. What is your portfolio return? (LG7)

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