The yield to maturity on one-year zero-coupon bonds is 7.8%. The yield to maturity on two-year zero-coupon bonds is 8.8%.

a. What is the forward rate of interest for the second year? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Forward rate of interest %

b. If you believe in the expectations hypothesis, what is your best guess as to the expected value of the short-term interest rate next year? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Short-term interest rate %

c. If you believe in the liquidity preference theory, is your best guess as to next year’s short-term interest rate higher or lower than in (b)?

Higher

Lower