Based on economists’ forecasts and analysis, one-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows:

1 R 1

=

5.65%

E ( 2 r 1 )

=

6.75%

L 2

=

0.05%

E ( 3 r 1 ) = 6.85% L3 = 0.10%

E ( 4 r 1 )

=

7.15%

L 4

=

0.12%

Using the liquidity premium theory, plot the current yield curve. Make sure you label the axes on the graph and identify the four annual rates on the curve both on the axes and on the yield curve itself. (LG 2-7)

AppendixLO1