Consider the following data from February 2018:

Current 1-year interest rate: 2%

Expected 1-year interest rates over the next four years: 2.4%, 2.6%, 2.7%

1. Determine what the Expectations Theory would suggest for the values of the 2-year and 3- bonds. (6 points)

1. If the actual 2-year rate was 2.2 and the 3-year rate was 2.4, compute the implied liquidity premium for each of these bonds. Does this align with our theory on the structure of the liquidity premium based on the preferred habitat assumptions? Why/why not? (6 points)

1. In reframing its employment mandate, the Federal Reserve has defined full employment as a "broad-based and inclusive" goal. As such, Chair Powell has stated publicly that the Fed will never declare victory on its employment goal. How might this communication strategy help control interest rates across the spectrum of terms to maturity? Use the Liquidity Premium Theory to justify your response. (6 points)