Question: Suppose that zero interest rates with continuous compounding are as follows: Maturity (years) Rate (% per annum) 1 1.5 2 1.8 3 2.0 4 2.6

Suppose that zero interest rates with continuous compounding are as follows:


Maturity (years)	Rate (% per annum)
1	1.5
2	1.8
3	2.0
4	2.6
5	3.1

a) Calculate the forward interest rates for the 2nd year. (2 marks)

b) Assume that liquidity preference theory correctly predicts the term structure. Is the forward rate that you obtained in part a) an upward-biased forecast or a downward-biased forecast of the one-year interest rate for the 2^nd year? Briefly explain. (2 marks)

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