Unit 6 Assessment — Interest Rates & the Cost of Money

🔢 Nominal Rate Build-Up

📐 Key Calculations

📈 Yield Curve Shapes

⚠️ Predatory Lending Signals

Nominal Rate Components

Quoted Rate Formular = r* + IP + DRP + LP + MRP

r* = Real Risk-Free RatePure return without inflation or risk

IP = Inflation PremiumExpected avg inflation over bond life

DRP = Default Risk PremiumCompensation for chance of non-payment

LP = Liquidity PremiumIlliquid assets require higher return

MRP = Maturity Risk PremiumLonger maturities = more interest rate risk

Key Rate Calculations

Fisher Approximationr_real ≈ r_nominal − Inflation Rate

Fisher Exact Formula(1+r_nom) = (1+r_real)(1+IP)

Payday Loan APRAPR = (Fee÷Loan) × (365÷Days) × 100

After-Tax YieldAT Yield = Nominal Rate × (1 − Tax Rate)

Tax-Equiv. Municipal YieldMuni Rate ÷ (1 − Tax Rate)

Yield Curve Shapes

Normal (Upward Slope)Long-term rates > short-term → economic growth expected

Inverted (Downward Slope)Short-term > long-term → recession often predicted

FlatShort ≈ long-term rates → uncertainty / transition

Term StructureRelationship between yield and maturity for same credit quality

Predatory Lending Red Flags

Payday APR Typical Range200% – 400%+ APR on short-term loans

CDFI AlternativeMission-driven lender · 8–18% APR · fair underwriting

Warning SignsHidden fees · balloon payments · rollover pressure

Credit Score Impact760+ → lowest rates · Below 620 → highest risk premium

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out of 100 points

—

Section 1

—/40

Multiple Choice

Section 2

—/20

True / False

Section 3

—/20

Short Answer

Section 4

—/20

Extended Response

⚠ Sections 3 & 4 are teacher-graded. Use the rubric selectors below to finalize the score.

Multiple Choice

Select the best answer · Includes rate decomposition and APR calculations

2 pts each · 40 pts

Click the best answer. Use the formula reference and credit score strip above. Show mental math where needed. Each question is worth 2 points.

True or False

Click TRUE or FALSE for each statement

2 pts each · 20 pts

Select TRUE or FALSE for each statement. Each is worth 2 points.

Short Answer

Show calculations where required + explain in 2–4 sentences · Teacher-graded

5 pts each · 20 pts

Answer in 2–4 complete sentences. Show every calculation step clearly. Rubric selectors appear after grading.

Extended Response — Community Borrower Advisory Report

Real-world rate & credit scenario · Show all work · Teacher-graded

20 pts

Read the scenario carefully. Write a well-organized advisory memo of at least 8 sentences. Show all calculations with labeled steps. Use and underline at least four unit vocabulary terms.

📋 Scenario — BBYM Financial Counseling Clinic: Three Community Borrowers

The BBYM Financial Counseling Clinic serves residents of the Birmingham-Bessemer corridor who need help evaluating borrowing decisions. Today three clients have come in with questions. As the student financial counselor, you must analyze each situation using the interest rate concepts from Unit 6.

Client 1 — Darius (Payday Loan)

Borrowed $400. Fee charged: $60. Loan term: 14 days. Wants to know the true APR.

Client 2 — Tamara (Mortgage Rate)

Credit score: 660. Wants a $160,000 30-year mortgage. Asks what improving her score to 760 would save monthly and over the loan life. Use the rate strip above.

Client 3 — Jerome (Rate Decomposition)

Quoted rate on a 5-year personal loan: 11.5%. r* = 2%, IP = 3%, LP = 0.5%, MRP = 1%. Wants to know the implied Default Risk Premium.

CDFI Alternative for Darius

A local CDFI offers a $400 emergency loan at 15% APR for 30 days. Compare total interest cost vs. the payday loan.

35 Write your advisory memo addressing all four parts: (a) Calculate Darius's payday loan APR and the total interest cost; compare it to the CDFI alternative and recommend which he should choose — justify with numbers; (b) Calculate Tamara's approximate monthly payment difference between a 7.11% and 6.50% rate on $160,000 over 30 years, estimate total savings over the loan life, and explain two concrete steps she can take to raise her credit score; (c) Solve for Jerome's implied Default Risk Premium using the nominal rate decomposition formula and interpret what that DRP level signals about how lenders view his creditworthiness; (d) Explain in 2–3 sentences how the yield curve shapes (normal, inverted, flat) affect borrowing decisions for community businesses and families. Use at least four underlined vocabulary terms.

📋 Teacher Scoring Rubric

Criterion	Excellent (Full)	Proficient (Partial)	Developing (Minimal)	Score
Part (a) — Darius Payday Loan APR = (60÷400)×(365÷14)×100 ≈ 391% · CDFI: ~$5 interest · Payday: $60 · Recommend CDFI	APR calculated correctly; CDFI cost computed; clear recommendation with dollar figures cited	APR correct but CDFI comparison thin or missing dollar amounts	Incorrect APR formula or no comparison made	/6
Part (b) — Tamara's Credit Score Monthly diff ≈ $56–$60 · 30-yr savings ≈ $20,000–$21,600 · Two credit-improvement steps	Payment difference estimated correctly using rate strip; total savings calculated; two specific credit steps given	Rate difference correctly identified but payment math incomplete; only one credit step	No payment calculation; vague credit advice	/5
Part (c) — Jerome's DRP DRP = 11.5% − (2%+3%+0.5%+1%) = 5%	DRP = 5% correctly derived with formula shown; interprets 5% as a high premium signaling meaningful default risk	Arithmetic correct but interpretation weak	Wrong formula or answer with no interpretation	/5
Part (d) — Yield Curve Impact	Clearly explains all three curve shapes and their real-world effect on community borrowers (e.g., inverted curve → recession signal → banks tighten credit)	Two curves explained with partial practical connection	One curve or purely definitional with no borrower impact	/4

Extended Response Total: — / 20

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Interest Rates &the Cost of Money

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Interest Rates &
the Cost of Money