1) Suppose that the short term rate of interest is currently 8% and that investors expect

it to remain at 8% next year. In the absence of liquidity premium, with no expectation

of a change in yields, YTM to 2year bond would be:

2) But what if the investors demand a risk premium to invest in 2year rather than

1year bond? If the liquidity premium is 1%, then the YTM on 2year bonds also would

be:

3) Draw the yield curves with no liquidity premium and 1% liquidity premium,

respectively.