Question

The Acme Bank and Storm Dood Company (good old "AB&SDC") is trying to determine what rate of interest they should pay on the new 6 month CDs they are trying to get customers to buy. Looking at the WSJ here's some interest rates they found:

Prime: 5%; LIBOR: 2.75%; Fed Funds: 1.0%; 10 Month T-Note: 2.42%; 3 Month T-Bill 1.75%.

Believe it or not, AB&SDC has a rather shaky reputation - so much so knowledgeable investors would require an additional 10% to buy Acme's CDs to make up for their high risk of defalut (ignor maturity and liquidity issues).

Given the above, what nominal rate of interest must Acme's CDs hav to pay?

Group of answer choices

The nominal rate of interest is 11.75%

The nominal rate of interest is 10.75%

The nominal rate of interest is 9 .75%

The nominal rate of interest is 8 .75%

The nominal rate of interest is 7 .75%

The nominal rate of interest is 6 .75%

Answer 1

	Rate of Interest
	= Real Rate*Inflation Premium + Risk
	Here Risk Free Rate gives us (Real Rate*Premium),
	but which rate should be used asRisk Free Rate is the question.
	Treasury bill rate will be used as Risk Free Rate, however
	there are 2 rates available, 1with 10 months and other with
	3 months.
	CDs are for 6 months, so most relevant rate will be 1.75%
	i.e. rate with 3 months.
	Also, Risk will be the rate which investor would additionally
	require i.e. 10%
	So,
	Rate of Interest
	= Real Rate*Inflation Premium + Risk
	= 1.75% + 10%
	= 11.75%