Suppose the yield to maturity on a one-year zero-coupon bond is 8%. The yield to maturity on a two-year zero-coupon bond is 10%. Answer the following questions (use annual compounding):
(a) According to the Expectations Hypothesis, what is the expected one-year rate in the marketplace for year 2?
(b) Consider an investor who only wants to invest for a year. She expects the yield to maturity on a one-year zero to be 6% next year. How should this investor arrange her portfolio today?
(c) If all investors behave like the investor in (b), what will happen to the equilibrium term structure according to the expectations hypothesis?