1. You observe the following market interest rates, for both borrowing and lending:
One year rate = 5%
Two year rate = 6%
One year rate one year from now = 7.25%
How can you take advantage of these rates to earn a riskless profit? Assume that the expectations theory for interest rates holds.
2. If the interest rates on one to five year bonds are currently 4%, 5%, 6%, 7%, and 8%, and the term premiums for one to five year bonds are 0%, 0.25%, 0.35%, 0.40%, and 0.50%, predict what the one year interest rate will be two years from now.