The table below gives current information on the interest rates for two two-year and two eight-year maturity investments. The table also gives the maturity, liquidity, and default risk characteristics of a new investment possibility (Investment 3). All investments promise only a single payment (a payment at maturity). Assume that premiums relating to inflation, liquidity, and default risk are constant across all time horizons.
Based on the information in the above table, address the following:
A. Explain the difference between the interest rates on Investment 1 and Investment 2.
B. Estimate the default risk premium.
C. Calculate upper and lower limits for the interest rate on Investment 3, r3?
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