The current yield curve for default-free zero-coupon bonds is as follows:

Maturity (Years) YTM (%)

1 ............10%

2 ............11

3 ............12

a. What are the implied 1-year forward rates?

b. Assume that the pure expectations hypothesis of the term structure is correct. If market expectations are accurate, what will be the pure yield curve (that is, the yields to maturity on 1- and 2-year zero coupon bonds) next year?

c. If you purchase a 2-year zero-coupon bond now, what is the expected total rate of return over the next year? What if you purchase a 3-year zero-coupon bond? Ignore taxes.

d. What should be the current price of a 3-year maturity bond with a 12% coupon rate paid annually? If you purchased it at that price, what would your total expected rate of return be over the next year (coupon plus price change)? Ignore taxes.