Week of February 25thFinance 301S.I.1. Define nominal rate of interest (r), real risk free rate of interest (r*), and nominal risk free rate(rrf).Nominal- measured in amount, not in real value. The quoted or stated rate. r= the quoted or nominal rate of interest on a given security.Real risk free r*- rate of interest that would exist on default free US treasuries if no inflation was expected. (B/C U.S. treasuries only have inflation risk)Nominal risk free rate rRF- the rate of interest on a security that is free of all risk: rRF is proxied by the T-bill rate or the T-bond rate. rRF includesan inflation premium.2. What are all of the determinants of interest rates? Write the equation for “r.”The determinants of the interest rate “r” are as follows- Inflation Premium: IP- a premium equal to expected inflation that investors add to the real risk free rate of return. (higher inflation=higher IP)- Default Risk Premium: DRP- the difference between the interstt rate of a U.S. Treasury bond and a coproate bond of equal maturityand marketability. (reflects the likelihood of default; higher likelihood = higher DRP)- Liquidity Premium: LP a premium added to the quilibrium interest rate on a security if that security cannot be converted to cash on short notice and at close to its “fair market value.” (the longer it takes to get it to cash, the higher the LP, & the further away from its market value, the higher the LP)- Maturity Risk Premium: MRP- a premium that reflects interest raterisko Interest rate risk- risk of capital losses due to changing interest rates over timeo The longer the security must be held, the higher the MRP3. Fill in the following table by placing a check mark indicating which premiums are included in which of the following securities.Interest PremiumMaturity Risk PremiumDefault Risk PremiumLiquidity PremiumST TreasuryLT TreasuryST CorporateLT Corporate 4. 30 day T-bills are currently yielding 5.5%. The following are current expected interest rate premiumsInflation Premium= 3.45%Liquidity Premium= 0.76%Maturity Risk Premium= 1.65%Default Risk Premium= 2.45%What is the real risk free rate of return?5. Suppose 2 year Treasury bonds yield 5.6%, while 1 year bonds yield 4%. r* is 1.5% and the maturity risk premium is 0.Using the expectations theory, what is the yield on a 1-year bond, 1 year from now?What is the expected inflation in Year 1? Year 2?6. A company’s 5 year bonds are yielding 7.85% each year. Treasury bonds with the same maturity are yielindg 4.82% per year, and the real risk free rate (r*) is 2.3%. The average inflation premium is 2.5% and thematurity risk premium is estimated to be 0.1 X (t-1)% where t= years to maturity. If the liquidity premium is .8%, what is the default risk premium on the corporate bonds?7. The economy is currently in a recession, and as a result, inflation thisyear is only expected to be 2.5%. Inflation in year 2 and after is expectedto increase to some constant level above 2.5%. Assume that expectationstheory holds and the real risk free rate r*=1.85%. If the yield on 3 year Treasury Bonds equals the 1 year yield plus 2%, what inflation rate is expected after year