Principles of Managerial Finance

a. Draw the supply curve and the demand curve for funds using the current data.

(Note:Unlike the functions in Figure 6.1, the functions here will not appear

as straight lines.)

b. Using your graph, label and note the real rate of interest using current data.

c. Add to the graph drawn in part athe new demand curve expected in the

event that the proposed tax legislation becomes effective.

d. What is the new real rate of interest? Compare and analyze this finding in

light of your analysis in part b.

6–3 Real and nominal rates interest Zane Perelli currently has $100 that he can

spend today on polo shirts costing $25 each. Instead he could invest the $100 in

a risk-free U.S. Treasury security that is expected to earn a 9% nominal rate of

interest. The consensus forecast of leading economists is a 5% rate of inflation

over the coming year.

a. How many polo shirts can Zane purchase today?

b. How much money will Zane have at the end of 1 year if he forgoes purchas-

ing the polo shirts today?

c. How much would you expect the polo shirts to cost at the end of 1 year in

light of the expected inflation?

d. Use your findings in parts band cto determine how many polo shirts

(fractions are OK) Zane can purchase at the end of 1 year. In percentage

terms, how many more or fewer polo shirts can Zane buy at the end of 1

year?

e. What is Zane’s real rate of return over the year? How is it related to the per-

centage change in Zane’s buying power found in part d? Explain.

6–4 Yield curve A firm wishing to evaluate interest rate behavior has gathered yield

data on five U.S. Treasury securities, each having a different maturity and all

measured at the same point in time. The summarized data follow.

U.S. Treasury security Time to maturity Yield

A 1 year 12.6%

B 10 years 11.2

C 6 months 13.0

D 20 years 11.0

E 5 years 11.4

With passage

Currently of tax legislation

Amount of funds Interest rate Interest rate Interest rate

supplied/demanded required by required by required by

($ billion) funds suppliers funds demanders funds demanders

$ 1 2% 7% 9%

53 6 8

10 4 4 7

20 6 3 6

50 7 2 4

100 9 1 3

296 PART 2 Important Financial Concepts

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