Question

1. One-year interest rate over the next five years are expected to be 15%, 16%, 17%, 18% and 19%.

Required:

i. Determine the interest rate on one to five-year bonds today.         

ii.   investors have preference for holding short-term bonds so their liquidity premium for holding one-to five-year bonds are 0%, 0.25%, 0.50%, 0.75% and 1%. Determine the interest rate on one to five-year bonds today.  

2. Determine the fractional-reserve lending cycle (5 times) with an 11% reserve ratio using initial amount of GHS10,500.
i. What is the total amount of money created?
ii. What is the maximum amount of money that the initial deposit can be expanded to?      

Answer 1

Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
Market Interest rates	15%	16%	17%	18%	19%
Present value factors(r,n)	0.87	0.86	0.85	0.85	0.84
One year Bond Interest rate	17.25	15/0.87
2 year Bond Interest rate	11.99	(0.86/1.15)*16
3 year Bond Interest rate	10.89	(0.85/(1.16*1.15))*17
4year Bond Interest rate	9.77	(0.85/(1.17*1.16*1.15))*18
5 years Bond Interest rate	8.67	(0.84/(1.18*1.17*1.16*1.15))*19

2)

Initial Amount deposited($)	10500
Reserve amount(10500*11%)	1155
Balance amount for loan issue	9345
Reserve multiplier Multiplier	5
Total amount of money created(5*1155)	5775
Maximum initial deposit extended to	16275