A forward contract exists for a unit of two-year government securities with delivery to take place three years from now. Suppose the price of these securities three years from now is uniformly distributed from a low $800 to a high of $1,400. The one-year expected riskless rate of interest is 5 percent for all periods under consideration.

1. If investors are risk neutral, what should be the current forward price?

2. Suppose now that investors are risk averse and that the forward price is $1,200. What do you know about the relationship between the market value of two-year government securities and overall consumption?

3. Continue to assume (as in (2)) that the current forward price (at time 0) is $1,200. One year from now (at time 1) the forward price for the same item and same delivery date is $1,000. Determine the time 1 value (to the buyer) of the contract that was agreed upon at time 0.