1. Suppose that the current i on 1-year bonds is 2% and the expected interest rate on all one- year 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:

1. be based on the expectations hypothesis of term structure of interest rates?
2. based on the liquidity-premium theory?