Consider the following term structure:

Term - Yield

1 1.5%

2 2.3%

3 3.5%

4 3.7%

Compute the implied forward rate on a one-year security for the beginning of years 2 and 3 (one year and two years from now). What is the economic interpretation of these rates according to the pure expectations theory? according to the liquidity preference (modified expectations) theory? Suppose that you believe that the actual future one-year rates will be greater than the implied forward rates. How would you alter your desired lending pattern to take advantage of your forecast?