5.Government economists have forecasted one-year T-bill rates for the following five years as follows:

Year

1-year rate

1

4.25%

2

5.15%

3

5.50%

4

6.25%

5

7.10%

You have liquidity premium 0.25% for the next two years and 0.50% thereafter. Would you be willing to purchase a 4-year T-bond at a 5.75% interest rate?

6.Consider the decision to purchase either a 5-year corporate bond or a 5-year municipal bond. The corporate bond is a 12% annual coupon bond with a par value of $1,000. It is currently yielding 11.5%. The municipal bond has an 8.5% annual coupon and a par value of $1,000. It is currently yielding 7%. Which of the two bonds would be more beneficial to you? Assume that your marginal tax rate is 35%.

7.The one-year interest rate over the next 10 years will be 3%, 4.5%, 6%, 7.5%, 9%, 10.5%, 13%, 14.5%, 16%, 17.5%. Using the pure expectations theory, what will be the interest rates on a 3-year bond, 6-year bond, and 9-year bond?

8.Using the information from the previous question, now assume that the investor prefers holding short-term bonds. A liquidity premium of 10 basis points is required for each year of a bond's maturity. What will be the interest rates on a 3-year bond, 6-year bond, and 9-year bond?

9.At your favorite bond store, Bonds-R-Us, you see the following prices:

a.1-year $100 zero selling for $90.19

b.3-year 10% coupon $1000 par bond selling for $1000

c.2-year 10% coupon $1000 par bond selling for $1000

Assume that the pure expectations theory for the term structure of interest rates holds, no liquidity or maturity premium exists, and the bonds are equally risky. What is the implied 1-year rate two years from now?

10.You observe the following market interest rates, for both borrowing and lending:

one-year rate = 5%

two-year rate = 6%

one-year rate one year from now = 7.25%

How can you take advantage of these rates to earn a riskless profit? Assume that the Pure Expectation Theory for interest rates holds.