Suppose the current one-year interest rate is 6.3%. One year from now, you believe the economy will start to slow and the one-year interest rate will fall to 5.3%. In two years, you expect the economy to be in the midst of a recession, causing the Federal Reserve to cut interest rates drastically and the one-year interest rate to fall to 2.3%. The one-year interest rate will then rise to 3.3% the following year, and continue to rise by 1% per year until it returns to 6.3%, where it will remain from then on.

a) If you were certain regarding these future interest rate changes, what two-year interest rate would be consistent with these expectations?

b) What current term structure of interest rates, for terms of 1 to 10 years, would be consistent with these expectations?

c) How does the one-year interest rate compare to the ten-year interest rate? Plot the yield- curve: how would you call a yield-curve of this shape?