Create an Excel spreadsheet to organize your answers to the following problem, and submit your Excel file as an attachment by clicking on the appropriate button on this page.
Part 1: Assuming that the pure rate of interest is 2%, and investors require an inflation premium of 3.5% and a risk premium of 6% to invest in a certain security, calculate the following rates using the multiplicative form of the Fisher model:
The nominal rate of interest on the security
The real rate of interest on the security
The risk-free rate of interest on securities of this maturity
(Please carry your final answers out to 2 decimal places.)
Part 2: An Inyo County California municipal bond is currently yielding 4.2%. What after-tax yield would you receive if you are in the following circumstances:
You are in a 28% federal tax bracket, and, as a California resident, you are in the 5% state tax bracket.
You are in a 33% federal tax bracket, and, as a Utah resident, you pay a 4% state income tax.
You are in a 15% federal tax bracket, and, as a Nevada resident, you pay no state income tax because Nevada has no income tax.
(Please carry your final answers out to 2 decimal places.)
Part 3: The expected return on a share of ExxonMobil stock in the U.S. is 15.6% while the expected return on a share of Royal Dutch Shell stock is 12.6% in the Netherlands. If the pure rate of return is 2% in both countries and the required risk premium is 6% for each company’s stock, what is the long-term expected inflation rate in each country if the multiplicative form of the Fisher model is used in making the calculations?
Sample Solution
