1. Assume 1 = 1.5%, and also assume that the one-period spot rate next period can take the following two values with equal probability: 1 = 1.75% + = 1.75% + 0.5% and 1 = 1.75% = 1.75% 0.5% . If Local Expectations Theory holds, calculate 2, ( ' 1 ), 1 1

2. Assume 1 = 1.5%, and also assume that the one-period spot rate next period can take the following two values with equal probability: 1 = 1.5% + = 1.5% + 0.5% and 1 = 1.5% = 1.5% 0.5%. Assume a Sharpe ratio of =0.5. If CAPM for bonds holds, calculate 2, (1 ), 1 1 .

3. Assume 1 = 1.5%, and also assume that the one-period spot rate next period can take the following two values with equal probability: 1 = 2.02% and 1 = 1.11%. Assume that the market price of risk =0.5. Use CAPM for bonds to calculate the current price of a two-period bond (M=100). Also, calculate the Sharpe ratio of the bond investment: 2 = (2 )1 (2 ) .