Suppose that the Expectation Theory is completely correct. Peoples belief about the path of interest rates on one-year zero-coupon Treasury bonds over the following 4 years is described by the following table.

1. (2pt) What is todays interest rate on a 4-year zero-coupon Treasury bond?

2. (2pt) What is the current price of a 4-year zero-coupon Treasury bond with a face value of $1,000?

3. (2pt) Suppose that you did not buy the 4-year bond in part b. Instead, you take the same amount of money (i.e. your answer to part b.) to buy a one-year zero-coupon Treasury bond and roll it over for 4 years. What is the probability that you will be paid more than $1,000 at the end of the fourth year? Explain.

1/3 Scenario Probability 1-year interest rate in year 1 1-year interest rate in year 2 1-year interest rate in year 3 1-year interest rate in year 4 4 8 6 4 B 1/4 4 2 4 5 5/12 4 6 2 1 1/3 Scenario Probability 1-year interest rate in year 1 1-year interest rate in year 2 1-year interest rate in year 3 1-year interest rate in year 4 4 8 6 4 B 1/4 4 2 4 5 5/12 4 6 2 1