Consider a three year bond with annual coupons (paid annually) of $100and a face value of $1,000 paid at maturity. Spot rates are observed as follows: r 1 =9%, r 2 =10%, r 3 =11%.

i) What is the current price of the bond?

ii) What is the expected price of the bond in 2 years?

- Under the Pure Expectations Hypothesis

- Under the Liquidity Preference Hypothesisassume f 3 overstates E[ 2 r 3 ] by 0.5%