Question

   Consider the following term structure:             Term    Yield             1      

  1.    Consider the following term structure:

            Term    Yield

            1        1.5%

            2        2.3%

            3        3.5%

            4        3.7%

      Compute the implied forward rate on a one-year security 1 year from now and 2 years from now.   What is the economic interpretation of these rates according to the pure expectations theory? …according to the liquidity preference (modified expectations) theory? Suppose that you believe that the actual future one-year rates will be greater than the implied forward rates. How would you alter your desired borrowing pattern to take advantage of your forecast?

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