Over the next three years, the expected path of 1-year interest rates is 3, 1 and 1 percent. The liquidity premiums for the one year rate are 1%, 2.0% and 2.5% 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.

Answer: ______________

2. Using the liquidity premium theory calculate what the current rate on a 3 year bond will be

Answer: ______________

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

Expected

Year One Year Bond Rates

1 4%

2 5%

3 6%

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

Answer:________________