The term structure for zero-coupon bonds is currently: P-639 Maturity (years) YTM (%)

1 4%

2 5 3 6 Next year at this time, you expect it to be:

Maturity (years) YTM (%)

1 5%

2 6 3 7

a. What do you expect the rate of return to be over the coming year on a 3-year zero-coupon bond?

b. Under the expectations theory, what yields to maturity does the market expect to observe on 1- and 2-year zeros at the end of the year?

c. Is the market’s expectation of the return on the 3-year bond greater or less than yours?