Interest rates

 The current yield curve is inverted. Specifically, the current one-year interest rate is 1R1 = 5%, and the yields of two- and three-year bonds are 1R2 = 4.5% and 1R3 = 4%, respectively. Suppose unbiased expectations hypothesis is true.

(a) Please solve for the market expectations of the one-year interest rates for next year and the year after (E(2r1) and E(3r1), respectively).

(b) (4 points) Suppose market expectation of the one-year interest rate two years later (E(3r1)) suddenly increased. Nothing else changed. What will happen to the yields of two-year bonds 1R2?