# Q. 3 ( 2 points) Use the following information to answer the questions: ?? = 3.6%,...

###### Question:

Q. 3 ( 2 points) Use the following information to answer the questions:

?? = 3.6%, ??+1 ? = 3.4%, ??+2 ? = 3.2%, ??+3 ? = 3.0%. Liquidity premiums = 0.2% for a 2-year maturity, 0.4% for a 3-year maturity, and 0.6% for a 4-year maturity. where ?? = today’s interest rate on a 1-year bond, ??+1 ? = future interest rate on a 1-year bond that is expected to prevail in year t +1, etc.

(1) Using the expectations theory, calculate today’s annual interest rate on 2-year, 3-year, and 4-year bonds, respectively. What does the yield curve look like?

(2) Using the liquidity premium theory, calculate today’s annual interest rate on 2-year, 3-year, and 4-year bonds, respectively. What does the yield curve look like?

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