Suppose that the current i on 1-year bonds is 2% and the expected interest rate on all oneyear bonds to be issued in the next five years is also 2%. Suppose that the illiquidity premium is: ln,t = (0.1)(n-1) (%) What will the interest rates on 2-, 3-, 4-, and 5-year bonds: a. be based on the expectations hypothesis of term structure of interest rates? b. based on the liquidity-premium theory?

Draw the yield curve for both part a and b.