Consider two risk-free zero-coupon bonds at time t=0

• B1: One year to maturity, face value $1,000, price 971
• B2: Two years to maturity, face value $1,000, price 907

1. (1pt) Calculate the yield to maturity of bond B1, R(0,1), and B2, R(0,2) (this calculation can be made by hand)

2. (1pt) According to the expectations hypothesis, what is E[R(1,1)], the expected yield to maturity on one-year bond from year 1 to year 2?
3. (1pt) According to the liquidity preference theory, is E[R(1,1)] smaller or larger than the one you calculated in question 2? Explain why.
4. (1pt) Suppose that E[R(1,1)] increases by 1% and R(0,1) stays the same. According to the expectation hypothesis, what should be the new value of R(0,2)?