1) Assume that the (expected) one-year interest rates over the next five years are 3%, 4%, 6%, 7%, and 8%. The interest rates on one- to five-year bonds are 3%, 4%, 5%, 6.5%, and 7.5%. Determine the liquidity premium for five-year bond!

2) Assume that cumulative default probabilities for BB rated securities are as follows: year 1: 3%, year 2: 5%, year 3: 10%, and year 4: 12%. What is the conditional default probability for a BB rated security in year 3?