Finance Chapter 5 Homework Discuss The Determinants The Shape The Yield

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Chapter 5

Interest Rates

I. Chapter Outline

The following chapter outline is correlated to the PowerPoint Lecture Slides. The PowerPoint slides

are referenced in bold. Alternative Examples to selected textbook examples are also available in the

PowerPoint Lecture Slides and are also referenced in bold.

5.1 Interest Rate Quotes and Adjustments (Slides 6–7)

• The Effective Annual Rate (Slide 6)

– Adjusting the Discount Rate to Different Time Periods (Slide 7)

• Table 5.1 Effective Annual Rates for a 6% APR with Different Compounding Periods

• Example 5.2 Converting the APR to a Discount Rate (Slides 16–17)

• PowerPoint Alternative Example 5.2 (Slides 18–20)

5.2 Application: Discount Rates and Loans (Slides 21–24)

5.3 The Determinants of Interest Rates (Slide 27–28)

• Global Financial Crisis: Teaser Rates and Subprime Loans

• Inflation and Real Versus Nominal Rates (Slide 27)

• Example 5.4 Calculating the Real Interest Rate (Slides 29–30)

– Interest Rate Determination

Berk/DeMarzo • Corporate Finance, Fourth Edition 19

5.4 Risk and Taxes (Slide 53)

54)

• Example 5.7 Discounting Risky Cash Flows (Slides 55–56)

5.5 The Opportunity Cost of Capital (Slide 62)

• Common Mistake: States Dig a $3 Trillion Hold by Discounting at the Wrong Rate

Chapter 5 Appendix Continuous Rates and Cash Flows (Slides 65–70)

II. Learning Objectives

5-2 Given an effective annual rate, compute the n-period effective annual rate.

5-4 Describe the relation between nominal and real rates of interest.

5-6 Describe the effect of higher interest rates on net present values in the economy.

5-8 Discuss the determinants of the shape of the yield curve.

5-10 Given the other two, compute the third: after-tax interest rate, tax rate, and before-tax interest

rate.

20 Berk/DeMarzo • Corporate Finance, Fourth Edition

III. Chapter Overview

Chapter 4 introduced the time value of money using risk-free rates of interest. Chapter 5 begins the

5.1 Interest Rate Quotes and Adjustments

This section discusses effective annual rate, annual percentage rate, and the rate per compounding

5.2 Application: Discount Rates and Loans

5.3 The Determinants of Interest Rates

Factors that may influence the willingness of individuals to borrow and lend are inflation, government

policy, and expectations of future growth. The text uses the multiplicative form of the Fisher

equation:

The text also emphasizes that when interest rates are low, more positive NPV projects are in the

economy. The Federal Reserve and other central banks use this information to stimulate investment or

5.4 Risk and Taxes

Two additional factors are important in determining interest rates: risk and taxes. All interest rates on

5.5 The Opportunity Cost of Capital

In summary, interest rates vary based on quoting conventions, the term of the investment, and risk.

The actual return investors keep depends on how the interest is taxed. The opportunity cost of capital

Berk/DeMarzo • Corporate Finance, Fourth Edition 21

IV. Spreadsheet Solutions in Excel

The following Problems for Chapter 5 have spreadsheet versions of the problems available: 2, 3, 10,