1.

The yield curve in a particular country is currently flat but recent news suggesting strong economic growth ahead is raising expectations that the central bank will increase interest rates.

(a) Explain how you would expect each of the following market participants to behave: (30 marks)

(i) Long-term bond investors

(ii) Bond speculators

(iii) Long-term bond issuers

(b) Explain with reasons what shape you expect the yield curve to take. (10 marks)

(c) Explain the limitations of the Pure Expectation Yield Curve Theory. Discuss one alternative theory that addresses these limitations. (30 marks)

(d) Provide an explanation for Malkiel's Second Bond Theorem: 'for a given change in yield, changes in bond prices are greater, the longer the term to maturity'. Use a diagram to help illustrate your answer. (30 marks)