Theories in Setting Interest Rates Migatsu Corporation wanted to borrow short-
term funds from Maybank. As the Chief Financial Officer (CFO) of the
company, you wanted to know what should be the one-year interest rate of a 2%
investment if the company wanted to generate a similar return to a two-year 5%
investment. Questions: a. What is the one-year interest rate that is anticipated in
the 2nd year? b. Assume instead that the computed one-year anticipated interest
rate included already the effect of liquidity premium and that the two-year
investment is 5.2%, what is the amount of liquidity premium that was
considered? 2.Determination of Interest Rates Tanasas Corporation plans to
borrow P3,000,000 funds from Hartendorp Financing. The risk - free rate
imposed on the loan is 8%. Currently, the BSP announces a 3% inflation. In the
following year, the monetary board expects a 1.5% increase in inflation.
Hartendorp still finds that the 3% debt margin remains to be relevant. How
much interest rate should Hartendorp Financing impose on Tanasas
Corporation?
Answer & Explanation
, To solve these questions, we need to apply the concepts of interest rate theories
and the determination of interest rates.
Question 1: Theories in Setting Interest Rates
a. What is the one-year interest rate that is anticipated in the 2nd year?
To find this, we use the formula for forward rates based on current spot rates:
[ (1 + r_2)^2 = (1 + r_1)(1 + f) ]
Where:
(r_2 = 5%) (two-year investment rate)
(r_1 = 2%) (one-year investment rate)
(f) is the forward rate for year two.
Plugging in values:
[ (1 + 0.05)^2 = (1 + 0.02)(1 + f) ]
Solving for (f):
[ (1.05)^2 = (1.02)(1+f) ] [ = 0.1025 \approx (0.02)(f+0.02) ] [ = f \approx \
frac{(0.1025)}{(0.02)} - 0 ]
term funds from Maybank. As the Chief Financial Officer (CFO) of the
company, you wanted to know what should be the one-year interest rate of a 2%
investment if the company wanted to generate a similar return to a two-year 5%
investment. Questions: a. What is the one-year interest rate that is anticipated in
the 2nd year? b. Assume instead that the computed one-year anticipated interest
rate included already the effect of liquidity premium and that the two-year
investment is 5.2%, what is the amount of liquidity premium that was
considered? 2.Determination of Interest Rates Tanasas Corporation plans to
borrow P3,000,000 funds from Hartendorp Financing. The risk - free rate
imposed on the loan is 8%. Currently, the BSP announces a 3% inflation. In the
following year, the monetary board expects a 1.5% increase in inflation.
Hartendorp still finds that the 3% debt margin remains to be relevant. How
much interest rate should Hartendorp Financing impose on Tanasas
Corporation?
Answer & Explanation
, To solve these questions, we need to apply the concepts of interest rate theories
and the determination of interest rates.
Question 1: Theories in Setting Interest Rates
a. What is the one-year interest rate that is anticipated in the 2nd year?
To find this, we use the formula for forward rates based on current spot rates:
[ (1 + r_2)^2 = (1 + r_1)(1 + f) ]
Where:
(r_2 = 5%) (two-year investment rate)
(r_1 = 2%) (one-year investment rate)
(f) is the forward rate for year two.
Plugging in values:
[ (1 + 0.05)^2 = (1 + 0.02)(1 + f) ]
Solving for (f):
[ (1.05)^2 = (1.02)(1+f) ] [ = 0.1025 \approx (0.02)(f+0.02) ] [ = f \approx \
frac{(0.1025)}{(0.02)} - 0 ]
