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ANSWER

1.

The steep upward-sloping yield curve at shorter maturities suggests that short-term interest rates are
expected to rise moderately in the near future because the initial, steep upward slope indicates that the
average of expected short-term interest rates in the near future is above the current short-term interest
rate. The downward slope for longer maturities indicates that short-term interest rates are eventually
expected to fall sharply. Since interest rates and expected in ation move together, the yield curve suggests
that the market expects in ation to rise moderately in the near future but fall later on.

2.

a)

year interest rate term

structure

1 4 5.00

2 6 5.00

3 11 7.00

4 15 9.00
 b)

year interest rate term

structure

1 3 5.00

2 5 4.00

3 13 7.00

4 15 9.00
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