 # Suppose that the short term risk free interest rate

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## Suppose that the short term risk free interest rate

suppose that the short-term risk-free interest rate this year is ri-8% and that the expected value of next year’s interest rate is r2-7.5%. Suppose that a two-year zero coupon bond with face value \$1000 sells for \$820.

a. What is the yield to maturity of the 2-year zero?

b. Your answer to (a) demonstrates that the yield curve can slope upward even if the market thinks that interest rates are likely to fall. To explain this result, calculate the forward rate for year 2. What is the liquidity premium?

c.Given yields on 1 and 2-year zero-coupon bonds, what would be the price and yield to maturity of a 2-year coupon bond with a coupon rate of 10%?

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Suppose that the short term risk free interest rate