1. Consider two scenarios. In the first, the nominal interest rate is 6 percent, and the expected rate of inflation is 4 percent. In the second, the nominal interest rate is 5 percent, and the expected rate of inflation is 2 percent. In which scenario would you rather be a lender? In which would you rather be a borrower?
2. Consider a coupon bond that has a face value of $100 and matures in 4 years. The coupon rate is 5% and coupons are paid annually. The current interest rate that lenders are willing to let the issuer borrow at is 7%. a. How much is the annual coupon payment? b. What is the value of this coupon bond today?
3. What is the standard deviation of returns from a truly risk-free investment?
4. Consider an investment that has a 20% probability of returning $600, a 35% probability of returning $750, and a 45% probability of returning $1,050. a. What is the expected value of the investment payoff? b. What is the standard deviation of the investment payoff (in dollars)?
5. In which of the following cases would you be more likely to decide whether to take on the risk involved by looking at a measure of the value at risk? a. You are unemployed and are considering investing your life savings of $10,000 to start up a new business. b. You have a full-time job paying $100,000 a year and are considering making a $1,000 investment in the stock of a well-established, stable company