18. Consider the following two bonds: a discount bond paying 100 in one year, selling at 93; a coupon bond paying 10 in one year, 110 in two years, selling at 95.

1. a) What is the one-year spot rate? What is the forward rate for the second year?

2. b) Suppose there is a liquidity premium of 50 basis points on two-year lending, under Preferred Habitat Theory. What is the market's expectation of what the one-year spot rate will be in the second year? (Hint - calculate Expected S12). What does the market expect the second bond's price to be at the beginning of the second year?

3. c) What is the total amount you expect to have at the end of year 2 if you buy the second bond? (Don't forget to reinvest the first-year coupon.)

18. Consider the following two bonds: a discount bond paying 100 in one year, selling at 93; a coupon bond paying 10 in one year, 110 in two years, selling at 95. a) What is the one-year spot rate? What is the forward rate for the second year? b) Suppose there is a liquidity premium of 50 basis points on two-year lending, under Preferred Habitat Theory. What is the market's expectation of what the one-year spot rate will be in the second year? (Hint - calculate Expected S2). What does the market expect the second bond's price to be at the beginning of the second year? c) What is the total amount you expect to have at the end of year 2 if you buy the second bond? (Don't forget to reinvest the first-year coupon.) 18. Consider the following two bonds: a discount bond paying 100 in one year, selling at 93; a coupon bond paying 10 in one year, 110 in two years, selling at 95. a) What is the one-year spot rate? What is the forward rate for the second year? b) Suppose there is a liquidity premium of 50 basis points on two-year lending, under Preferred Habitat Theory. What is the market's expectation of what the one-year spot rate will be in the second year? (Hint - calculate Expected S2). What does the market expect the second bond's price to be at the beginning of the second year? c) What is the total amount you expect to have at the end of year 2 if you buy the second bond? (Don't forget to reinvest the first-year coupon.)