karoliukas

A major brokerage house is currently selling an investment product that offers an 8% rate of return, compounded monthly. Based on this information, it follows that this investment has:

A) an effective annual rate of 8.00%.

B) a periodic interest rate of 0.667%.

C) a stated rate of 0.830%.

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Periodic rate = 8.0 / 12 = 0.667. Stated rate is 8.0% and effective rate is 8.30%.

karoliukas

Which of the following is the most accurate statement about stated and effective annual interest rates?

A) The stated rate adjusts for the frequency of compounding.

B) So long as interest is compounded more than once a year, the stated annual rate will always be more than the effective rate.

C) The stated annual interest rate is used to find the effective annual rate.

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The effective annual rate, not the stated rate, adjusts for the frequency of compounding. The nominal, stated, and stated annual rates are all the same thing.

karoliukas

A local bank offers an account that pays 8%, compounded quarterly, for any deposits of $10,000 or more that are left in the account for a period of 5 years. The effective annual rate of interest on this account is:

A) 4.65%.

B) 9.01%.

C) 8.24%.

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(1 + periodic rate)m − 1 = (1.02)4 − 1 = 8.24%.

karoliukas

The real risk-free rate can be thought of as:

A) exactly the nominal risk-free rate reduced by the expected inflation rate.

B) approximately the nominal risk-free rate reduced by the expected inflation rate.

C) approximately the nominal risk-free rate plus the expected inflation rate.

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The approximate relationship between nominal rates, real rates and expected inflation rates can be written as:

Nominal risk-free rate = real risk-free rate + expected inflation rate.

Therefore we can rewrite this equation in terms of the real risk-free rate as:

Real risk-free rate = Nominal risk-free rate – expected inflation rate

The exact relation is: (1 + real)(1 + expected inflation) = (1 + nominal)

karoliukas

T-bill yields can be thought of as:

A) nominal risk-free rates because they contain an inflation premium.

B) nominal risk-free rates because they do not contain an inflation premium.

C) real risk-free rates because they contain an inflation premium.

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T-bills are government issued securities and are therefore considered to be default risk free. More precisely, they are nominal risk-free rates rather than real risk-free rates since they contain a premium for expected inflation.