Question: The current yield curve is inverted. Specifically, the current one-year interest rate is 1 R 1 = 5%, and the yields of two- and three-year

The current yield curve is inverted. Specifically, the current one-year interest rate is ₁R₁= 5%, and the yields of two- and three-year bonds are ₁R₂= 4.5% and 1R₃= 4%, respectively. Suppose unbiased expectations hypothesis is true.

1.Please solve for the market expectations of the one-year interest rates for next year and the year after (E(₂r₁) and E(₃r₁), respectively).

2.Suppose market expectation of the one-year interest rate two years later (E(₃r₁)) suddenly increased. Nothing else changed. What will happen to the yields of two-year bonds ₁R₂?

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