To account for risk in the expectations theory of the term structure, we:
A)set the period rate equal to the risk premium.
B)add a risk premium to the current period's 1-year interest rate.
C)add a risk premium to the average of the current one-period rate and expected rates over the next periods.
D)divide the average of the current one-period rate and expected rates over the next periods by a risk premium.

Question

Quizplus · Accepted Answer

The expectations theory suggests that long-term interest rates are an average of current and expected future short-term rates. To account for risk, a risk premium is added to this average to reflect the uncertainty and potential variability in future rates.

To Account for Risk in the Expectations Theory of the Term