1. The yield to maturity on zero-coupon bonds with one-year maturity is 7%, the yield to maturity on zero-coupon bonds with two-year maturity is 9%, and the yield to maturity on zero-coupon bonds with three-year maturity is 11%. The zero-coupon bonds have no default risk. Assume the liquidity preference theory of the term structure is correct. The liquidity premium in year 2 is 2%, and the liquidity premium in year 3 is 4%. Given the information, the expected short rate for year 2 is around___________ than the expected short rate for year 3.

1. 1.46% lower
2. 2.07% lower
3. 2.11% higher
4. 1.47% higher

2.

1. Based on your analyses, todays pure yield curve is upward sloping. You believe in the pure expectations hypothesis of the term structure of interest rates. Which of the following statements is false?

• Statement 1: You would buy a BBB-rated bond with coupon rate of 10% and time to maturity of 20 years rather than buy an AA-rated bond with coupon rate of 10% and time to maturity of 20 years.
• Statement 2: You would sell an AA-rated bond with coupon rate of 10% and time to maturity of 20 years rather than sell a BBB-rated bond with coupon rate of 10% and time to maturity of 20 years.
• Statement 3: You would sell a Treasury bond with coupon rate of 11%, time to maturity of 20 years, and yield to maturity of 8% rather than sell a Treasury bond with coupon rate of 10%, time to maturity of 20 years, and yield to maturity of 8%.
• Statement 4: You would buy a Treasury bond with coupon rate of 11%, time to maturity of 20 years, and yield to maturity of 8% rather than buy a Treasury bond with coupon rate of 10%, time to maturity of 20 years, and yield to maturity of 8%.

1. Statement 1
2. Statement 2
3. Statement 3
4. Statement 4