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Twisted Rail, Inc is a new brewery and just opened its doors. It recently received a...

Twisted Rail, Inc is a new brewery and just opened its doors. It recently received a 2-year loan from GNBank. The rate on the loan is 12%. TR's liquidity risk is 3%, its maturity risk is expected to be 2%, and the liquidity risk is 0.5%. The pure rate of interest is 2%. Inflation is expected to be 2% in year 1. What does the lender anticipate the inflation rate to be in year 2?

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Answer #1

Yield on Loan = Real risk free rate + Inflation premium + Liquidity premium + Default risk premium + Maturity risk premium

12% = 2% + Inflation premium + 3% + 2% + 0.5%

Inflation premium = 4.5%

Inflation premium is average of inflation over life of loan

Inflation premium = (Inflation Yr 1 + Inflation Yr 2)/2

4.5% = (2% + Inflation Yr 2)/2

9% = (2% + Inflation Yr 2)

Inflation Yr 2 = 9% - 2% = 7%

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