Question

1. What does the interest rate represent? How would a period of high inflation affect interest rates? In your own words, what does the “real rate of interest” mean?

2. What are the three pieces that make up the returns on Treasury securities? The first term you explained above. Why is an investor compensated for the second and third terms?

3. Fill in the blanks for the following with either “higher” or “lower”: Bonds with higher levels of risk result in ______ interest rates. Bonds with lower levels of risk result in ______ interest rates.

Please answer all 3!!!

Answer 1

Answer 1)

interest rates is the rate of interest at which the invested money grows
Amount = Principal x (1+r)ⁿ

The interest rate in US is set by US Fed and is the interest received at parking the money with central banks.
When the inflation increases the nominal interest rate increases.

Nominal interest rate = Real interest rate + inflation
Real interest rate = Nominal interest rate - inflation

Answer 2)

The three pieces that make up returns on Treasury securities are interest payments, liquidity risk and credit risk. The investor is compensated for liquidity risk and credit risk by higher yields.

Answer 3)

Bonds with higher levels of risk result in Higher interest rates. Bonds with lower levels of risk result in Lower interest rates.