Assume that the current 1-year interest rate is 1%. It is expected that the 1-year rate will rise to 3% next year, and then to 5% the following year. The market currently puts a liquidity premium of 0.25% on 2-year bonds and 0.75% on 3-year bonds.

a) According to the Liquidity Premium Theory, what should be the current 2-year interest rate? What should be the current 3-year interest rate?

b) Is this yield curve inverted or not? How can you tell?