The current yield curve for default-free zero-coupon bonds is as follows:

Maturity

YTM (%)

1 10%

2 11

3 12

a) What are the implied 1-year forward rates for years 2 and 3 expressed as a %? (4 marks)

b) Assume that the pure expectations hypothesis of the term structure is correct. If market expectations are accurate, what will be the pure yield curve expressed as a %. (that is, the yields to maturity on 1- and 2-year zero coupon bonds) next year? (4 marks)

c) Discuss the theories of the term structure of interest rates. Include in your discussion the differences in the theories, and the advantages/disadvantages of each. (4 marks