The Acme Bank and Storm Dood Company (good old "AB&SDC") is trying to determine what rate of interest they should pay on the new 6 month CDs they are trying to get customers to buy. Looking at the WSJ here's some interest rates they found:
Prime: 5%; LIBOR: 3.25%; Fed Funds: 1.5%; 10 Month T-Note: 2.42%; 3 Month T-Bill 1.45%.
Believe it or not, AB&SDC has a rather shaky reputation - so much so knowledgeable investors would require an additional 8% to buy Acme's CDs to make up for their high risk of defalut (ignore maturity and liquidity issues).
Given the above, what nominal rate of interest must Acme's CDs have to pay?
Answer:
Nominal rate of interest = Risk free rate + Risk premium
The CDs are of 6 months.
6 month T bill rate is not given. 3 Month T-Bill rate is = 1.45%.
Risk free rate = 1.45%
Risk premium = 8%
Hence:
Acme must pay nominal rate of interest on Acme's CDs = 1.45% + 8% = 9.45%
Acme must pay nominal rate of interest on Acme's CDs = 9.45%
The Acme Bank and Storm Dood Company (good old "AB&SDC") is trying to determine what rate...
The Acme Bank and Storm Dood Company (good old "AB&SDC") is trying to determine what rate of interest they should pay on the new 6 month CDs they are trying to get customers to buy. Looking at the WSJ here's some interest rates they found: Prime: 5%; LIBOR: 3.25%; Fed Funds: 1.5%; 10 Month T-Note: 2.42%; 3 Month T-Bill 1.25%. Believe it or not, AB&SDC has a rather shaky reputation - so much so knowledgeable investors would require an additional...