3. (23pts) Consider the following term structure of interest rates. Table 1: Term structure of interest rates 2 3 4 5 6 Year 1 7 8 9 10 Spot rate 1% 1.50% 1.80% 2.00% 2.50% 2.70% 2.80% 2.90% 2.95% 3% (1) (6pts) Consider a 4-year bond with face value $1000 and changing coupon rates. Coupons are paid annually and the coupon rate is 3% for the first two years and it becomes 4% for the last two years. Calculate the current price of this bond. (2) (6pts) Calculate the one-year forward rates n years from today for n=1,2,3. The term structure of liquidity premiums is as follows. Table 2: Term structure of liquidity premiums Year 1 2 3 4 Spot rate 0.1% 0.20% 0.30% 0.40% (3) (6pts) Suppose you plan to hold the bond for three years. What is the expected annual rate of return in the holding period? (4) (5pts) The Fed just rolled out a massive quantitative easing program, in which they will buy large amounts of 10 year bonds. What would happen to the 10-year spot rate? Explain your answer using the demand-supply diagram. 3. (23pts) Consider the following term structure of interest rates. Table 1: Term structure of interest rates 2 3 4 5 6 Year 1 7 8 9 10 Spot rate 1% 1.50% 1.80% 2.00% 2.50% 2.70% 2.80% 2.90% 2.95% 3% (1) (6pts) Consider a 4-year bond with face value $1000 and changing coupon rates. Coupons are paid annually and the coupon rate is 3% for the first two years and it becomes 4% for the last two years. Calculate the current price of this bond. (2) (6pts) Calculate the one-year forward rates n years from today for n=1,2,3. The term structure of liquidity premiums is as follows. Table 2: Term structure of liquidity premiums Year 1 2 3 4 Spot rate 0.1% 0.20% 0.30% 0.40% (3) (6pts) Suppose you plan to hold the bond for three years. What is the expected annual rate of return in the holding period? (4) (5pts) The Fed just rolled out a massive quantitative easing program, in which they will buy large amounts of 10 year bonds. What would happen to the 10-year spot rate? Explain your answer using the demand-supply diagram