The yield to maturity on one-year zero-coupon bonds is 7.7%. The yield to maturity on two-year zero-coupon bonds is 8.7%.

a. What is the forward rate of interest for the second year?

Forward Rate of Interest % ____

b. If you believe in the expectations hypothesis, what is your best guess as to the expected value of the short-term interest rate next year?

Short term interest rate % ____

c. If you believe in the liquidity preference theory, is your best guess as to next years short-term interest rate higher or lower than in (b)?

Higher

Lower