Sources of finance (20 marks)

1. The current yield curve for risk-free zero-coupon bonds is given below:

Years to maturity	Interest rate (%, p.a)
1	4.00
2	4.25
3	5.00
4	5.35
5	6.20

1. Assuming that the expectations theory holds for this term structure, calculate the expected one-year spot rates for the second, third and fourth year. (9 marks)
2. Using the expectation theory, what is/ are the reason(s) for the shape of the above yield curve? (1.5 marks)
3. Using the liquidity premium theory, what is/ are the reason(s) for the shape of the above yield curve? (1.5 marks)

2. Estimate the price of a share that has just paid an annual dividend of $2 per share assuming that dividends are expected to grow at a rate of 5% p.a. for the next year, a further 7% for the second year and then a further 4% p.a. thereafter. Assume dividends are paid at each year-end and that the required rate of return on equity is 10% p.a. (8 marks)