1. One-year interest rates over the next three years is expected to be 1%, 3%, 5%. The liquidity premium for one- to three-year bonds: 0%, 0.25%, 0.5%. Find the interest rate on the three year bond. 2. The one year interest rate today is 5% on a Tbond. The two year interest is 7% on the Tbond. What is the market predicting about the interest rate on a one year bond one year from now solely based on the expectations theory? 3. Debt issued by Southeastern Corporation currently yields 11%. A municipal bond of equal risk currently yields 8%. Your marginal tax bracket is 30%. Which is the better buy? Use formula after-tax yield = yield * ( 1- tax) 4. Below is the yield curve as of December 2009. What is the market predicting about future interest rates in 1 year, 2 years, and 10 years? What is the general direction, no numbers required. YIELD CURVE CURRENT PREVIOUS CLOSE Spread Widest Since 1980 3m 6m 1 2 3 4y5y by 7 8 9 10 15 20 30 1. One-year interest rates over the next three years is expected to be 1%, 3%, 5%. The liquidity premium for one- to three-year bonds: 0%, 0.25%, 0.5%. Find the interest rate on the three year bond. 2. The one year interest rate today is 5% on a Tbond. The two year interest is 7% on the Tbond. What is the market predicting about the interest rate on a one year bond one year from now solely based on the expectations theory? 3. Debt issued by Southeastern Corporation currently yields 11%. A municipal bond of equal risk currently yields 8%. Your marginal tax bracket is 30%. Which is the better buy? Use formula after-tax yield = yield * ( 1- tax) 4. Below is the yield curve as of December 2009. What is the market predicting about future interest rates in 1 year, 2 years, and 10 years? What is the general direction, no numbers required. YIELD CURVE CURRENT PREVIOUS CLOSE Spread Widest Since 1980 3m 6m 1 2 3 4y5y by 7 8 9 10 15 20 30