Assume the interest rate on a 1 year bond is 4 percent and is expected to have a path of 3, 2, 1, and 0.5 percent over the next four years and the liquidity premium is given by ln,t = (n-1)(0.01)% 

a. Calculate the yield today on 2 year, 3 year, 4 year and 5 year bonds respectively. Draw the yield curve. 

b. What information do we derive on future economic growth and inflation from this yield curve? 

c. If the yield curve suddenly becomes flatter how would you revise your expectations of interest rates and thus inflation in the future?

Answer rating: 100% (QA)

a year Int Rate LP Yield rate 1 4 000 400 2 3 001 301 ... View the full answer