1. Assume that your boss agrees with your forecast for one-year interest rates to be 2%, 3%, 4%, 5%, and 6% over the next five years, but she suggests that you account for investor preference for short-term debt by setting the liquidity premium for one-year to five-year bonds as 0%, 0.20%, 0.40%, 0.70%, and 0.9%, respectively.

You are now required to respond to the following questions, assuming the liquidity preference theory is true:

1. Based on this information, what are the interest rates on a two-year bond?

2. Based on this information, what are the interest rates on a five-year bond?

3. Given the new information, you are required to evaluate the shape of the yield curve.