4. Suppose that currently one-year pure-discount bonds yield 2.2% and two-year pure-discount

bonds yield 2.8%.

a. Calculate the implied forward rate (yield) for a one-year bond to be issued next year.

b. If you believe the pure expectations model, what do you predict will be the one-year rate next

year?

c. If, instead, you believe the liquidity preference model, would your predicted one-year rate for

next year be higher or lower than your answer to (b)? Explain.

5.

Suppose the New York stock exchange were to impose a fee of $.0025 per share in addition to

all existing fees and costs on all transactions carried out on the exchange.

a. What effect, if any, would this tend to have on the price of securities trading on the exchange?

What effect on their expected returns? Explain your reasoning. (Remember, the exchange-

imposed fee is not built into quoted securities prices. It is collected by the exchange directly

from buyers and sellers as an additional expense.)

b. Suppose Fastrac Inc. now trades for 24 1/8 bid, 24 1/4 asked, while SloMo Enterprises trades

at 25 3/4 bid 27 asked. What, if any, differences might you expect to observe between investors

holding Fastrac Inc. and those holding SlowMo Enterprises? Explain.

c. Which of these two securities would find its returns most affected by the additional cost of

trading? Why?