Assume the Expectations Hypothesis regarding the term structure of interest rates is correct.If the current one-year interest rate is 3% and the one-year-ahead expected one-year interest rate is 5%, then the current two-year interest rate should be:
A)3%.
B)5%.
C)4%.
D)8%.

Question

Quizplus · Accepted Answer

According to the Expectations Hypothesis, the two-year interest rate is the average of the current one-year rate and the expected one-year rate one year from now. Therefore, (3% + 5%) / 2 = 4%.

Assume the Expectations Hypothesis Regarding the Term Structure of Interest