It is now date zero. Currently the yield on a one-year bond is 10%, on a two-year bond is 15%, and on a three-year bond is 17%. Furthermore, everyone expects inflation to run at 5% this year, 10% next year and at 15% the year after that. Assume that the pure expectations model correctly describes the behavior of the term structure. The nominal interest rate on a one-year bond originating date 1 and maturing date 2 is 20%. However, you are firmly convinced that next year's one-year nominal interest rate will be 12%.

a. Describe the steps you would take today to put yourself in a position to profit if your belief is correct.

b. If next year it turns out you are right and the one-year interest rate is indeed 12%, describe the steps you would take at that time and demonstrate that a profit results.