1.
Trish Harris has deposited $2,500 today in an account paying 6 percent interest
annually. What would be the simple interest earned on this investment in five
years? If the account paid compound interest, what would be the interest-on-
interest in five years?
2. Joachim Noah is investing $5,000 in an account paying 6.75 percent annually for
three years. What is the interest-on-interest if interest is compounded?
3. Chung Lee wants to invest $3,000 in an account paying 5.25 percent compounded
quarterly. What is the interest on interest after four years?
4. Dat Nguyen is depositing $17,500 in an account paying an annual interest rate of
8.25 percent compounded monthly. What is the interest-on-interest after six years?
5. Richard Delgado invested $10,000 in a money market account that will pay 5.75
percent compounded daily. How much will the interest-on-interest be after two
years?
6. How does the after-tax yield on a $1,000,000 municipal bond with a coupon rate
of 8% paying interest annually compare with that of a $1,000,000 corporate bond
with a coupon rate of 10% paying interest annually? Assume that you are in the
25% tax bracket.
7. Debt issued by Southwest Airways currently yields 24%. A municipal bond of
equal risk currently yields 16%. At what marginal tax rate would an investor be
indifferent between these two bonds?
8. Assuming that the expectations theory is the correct one of the term structure,
calculate the interest rates in the term structure for maturities one to six years:
a. 4%, 4%, 5%, 6%, 6%, 6%
b. 5%, 5%, 4%, 4%, 4%, 4%
c. Explain what is happening to yield curve.
9. Refer to the problem 8. Assume that instead of the expectations theory, the
liquidity premium theory takes place. What will be your answer to parts a and b of
problem 8, if the following liquidity premiums are expected? 0%; 0.25%, 0.5%,
0.75%, 1%, and 1.25% respectively?
10. The one-year interest rate over the next eight years will be 4%, 5.5%, 6%, 8.5%,
10%, 11.5%, 14%, and 15.5%. Using the expectations theory, what will be the
interest rates on a four-year bond, a six-year bond, and an eight-year bond?
11. Suppose that the expectations theory is true and that you can buy a three-year bond
with an interest rate of 6% or three consecutive one-year bonds with interest rates
of 4%, 5%, and 6%. Which option would you choose to undertake?
12. One-year T-bill rates over the next five years are expected to be 4%, 5%, 6%,
6.5%, and 8%. If five- year T-bonds are yielding 35.5%, what is the liquidity
premium on this bond?