1. Assume that $1 worth of one-period bonds issued at the end of period 0 pays out $(1+R1)during period 1. Assume that $1 worth of one-period bonds issued at the end of period 1 will pay out $(1+R2)during period 2. Suppose that people also market a two-period bond at the end of period 0. One dollar's worth of this asset pays out $(1+2R)during period 2. Lenders from date 0 to date 2 have the option of holding a two-period bond or a succession of one period bonds. Borrowers have a similar choice between negotiating a two-period loan or two successive one-period loans.
   1. What must be the relationship ofR toR1andR2 ? Explain the answer from the standpoint of borrowers and lenders.
   2. IfR2>R1, what is the relation betweenR(the current long-term interest rate) andR1(the current short-term interest rate)? The answer is an important result about the term structure of interest rates.