Suppose that the yields-to-maturity on one-, two-, and three-year bonds are 10, 11, and 12 per cent, respectively. On each bond, the coupon rate is 12 per cent. Answer the following questions according to the expectations theory of the term structure, and explain your reasoning.
a) What are the expected short-term (one-year bond) interest rates for next year and the year after?
b) Define holding-period return. What is the expected holding-period return next year for two-year bonds?
c) During the first year, is the price of three-year bonds expected to rise or fall?