In a sunny climate you has the opportunity to install a solar water heater in your home for a cost of $2,900. After installation the solar water heater will produce a small amount of hot water every day, forever, and will require no maintenance. The interest rate is 5% per year.

Required

(a) How much must you save on water heating costs every year if this is to be a sound investment?

Suppose that the current one-year Treasury-bill rate is 3.15% and the expected one-year rate 12 months from now is 4.25%.

Required

(b) According to the unbiased expectations theory, what should be the current rate for a twoyear Treasury security?