Over the next three years, the expected path of 1-year interest rates is 4, 1, and 1 percent. The liquidity premiums for the one-year rate are 0%, 1.0%, and 1.5% for years 1, 2, and 3.

1. Using the above data and the expectations theory of the term structure, calculate what the current rate on a 3-year bond will be.
2. Using the liquidity premium theory calculate what the current rate on a 3-year bond will be.

3. Now, assume the expected one-year rates for the next three years are as follows:

   Year Expected One Year Bond Rates

   1 3%

   2 4%

   3 6% And the 3-year bond rate is 5%. Please calculate the liquidity premium for the 3-year bond.