Suppose that a 1-year zero-coupon bond with face value $100 currently sells at $88.64, while a 2-year zero sells at $78.45. You are considering the purchase of a 2-year-maturity bond making annual coupon payments. The face value of the bond is $100, and the coupon rate is 6% per year.

a. What is the yield to maturity of the 2-year zero? The 2-year coupon bond? (Do not round intermediate calculations. Round your answers to 3 decimal places. Omit the "%" sign in your response.)

Yield to Maturity

2-year zero %

2-year coupon bond %

b. What is the forward rate for the second year? (Do not round intermediate calculations and rounded to whole number. Omit the "%" sign in your response.)

Forward rate %

c. If the expectations hypothesis is accepted, what are (1) the expected price of the coupon bond at the end of the first year and (2) the expected holding-period return on the coupon bond over the first year? (Do not round intermediate calculations. Round your answers to 2 decimal places. Omit the "$" & "%" signs in your response.)

Expected price $    

Holding-period return %

d. Will the expected rate of return be higher or lower if you accept the liquidity preference hypothesis?

Higher

Lower