For questions be sure to show your work and/or explain your reasoning:

Suppose that currently one-year pure-discount bonds yield 2.2% and two-year pure-discount bonds yield 2.8%.

a. Calculate the implied forward rate (yield) for a one-year bond to be issued next year.

b. If you believe the pure expectations model, what do you predict will be the one-year rate next year?

c. If, instead, you believe the liquidity preference model, would your predicted one-year rate for next year be higher or lower than your answer to (b)? Explain.