Question -
1. Describe the difference between the "nominal interest rate" offered on a loan and the "real interest rate"? How is a nominal interest rate converted into its equivalent real interest rate?
2. Suppose you buy a 3 year, zero coupon bond with a face value of $1000 at the time it is issued.
a. If you buy the bond for $920, what is its nominal yield to maturity?
b. What is the bond's ex-ante real yield to maturity, if the inflation rate is expected to average 2% per year over the next 3 years?
c. Suppose that after 2 years, you sell the bond for $990. What nominal holding period rate of return have you earned?
d. What was your (ex-post) real holding period rate of return if the inflation rate was2% over the two years that you held the bond?
3. According to the theory of portfolio choice (see chapter 5 of the textbook), what are the four primary determinants of demand for any asset? Which of those determinants would be affected by an increase in the current price of the asset, all else equal? What would happen to the quantity of the asset demanded as a consequence? Explain.