1. The one-year spot interest rate isr₁= 5%, and the two-year rate isr₂= 6%. If the expectations theory is correct, what is the expected one-year interest rate in one years time?

2.The two-year interest rate is 10% and the expected annual inflation rate is 5%.

If the expected rate of inflation suddenly rises to 7%, what will be the new nominal rate?

3.A 10-year U.S. Treasury bond with a face value of $1,000 pays a coupon of 5.5% (2.75% of face value every six months). The reported yield to maturity is 5.2% (a six-month discount rate of 5.2/2 = 2.6%).

a.What is the present value of the bond?

b.If the yield to maturity changes to 1%, what will be the present value?

c.If the yield to maturity changes to 8%, what will be the present value?

d.If the yield to maturity changes to 15%, what will be the present value?

4.

Suppose that you buy a two-year 8% bond at its face value.

a-1.What will be your total nominal return over the two years if inflation is 3% in the first year and 5% in the second?

a-2.What will be your real return?

B. Now suppose that the bond is a TIPS. What will be your total 2-year real and nominal returns?

real return?

nominal return?