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    Finance (risk) questions: Little Monsters, Inc. as it relates to inflation, market interest rates, and more

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    10. Little Monsters, Inc., borrowed $1,000,000 for two years from NorthernBank, Inc., at an 11.5% interest rate. The current risk-free rate is 2%, and Little Monsters' financial condition warrants a default risk premium of 3% and a liquidity risk premium of 2%. The maturity risk premium for a two-year loan is 1%, and inflation is expected to be 3% next year. What does this information imply about the rate of inflation in the second year?

    14. You observe the following market interest rates, for both borrowing and lending:

    One-year rate = 5%
    Two-year rate = 6%
    One-year rate one year from now = 7.25%

    How can you take advantage of these rates to earn a riskless profit? Assume that the pure expectations theory for interest rates holds.

    15. If the interest rates on one- to five-year bonds are currently 4%, 5%, 6%, 7%, and 8% and the term premiums for one- to five-year bonds are 0%, 0.25%, 0.35%, 0.40%, and 0.50%, predict what the one-year interest rate will be two years from now.

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    Solution Summary

    In the attached Word document, this solution uses step by step equations to find one-year interest rate, riskless profit, and rate of inflation.