If i (t) and i (t) are the interest rates on a 2-year and 1-year bond issued this year and i (t + 1) 2 1 1
Is the 1-year rate next year, the equilibrium relationship between the 2-year bond and the two
1-year bonds is:
A)i (t) = [i (t + 1) - i (t + 1)]12. 2 1 1
B)i (t) = 2·[i (t) + i (t + 1)]. 2 1 1
C)i (t) = (1/2)[i (t) + i (t + 1)].
D)i (t) = i (t) + i (t + 1). 2 1 1

Question

Quizplus · Accepted Answer

According to the expectations hypothesis, the long-term interest rate (2-year bond rate) is the average of the current short-term interest rate (1-year bond rate) and the expected short-term interest rate (1-year bond rate next year). Therefore, i(t) = (1/2)[i(t) + i(t+1)].

If I (T) and I (T) Are the Interest Rates