The expectations theory posits that
A)the long-term rate is the geometric average of the current short-term rate and short-term rates expected to prevail over the term to maturity of the long-term security.
B)the short-term rate is the geometric average of the current long-term rate and long-term rates expected to prevail over the term to maturity of the short-term security.
C)the long-term rate is the geometric average of the current long-term rate and short-term rates expected to prevail over the term to maturity of the long-term security.
D)the long-term rate is the geometric average of the current short-term rate and the rate of inflation expected to prevail over the term to maturity of the long-term security.

Question

Quizplus · Accepted Answer

The expectations theory states that the long-term rate is the geometric average of the current short-term rate and the expected short-term rates over the term to maturity of the long-term security. This is because investors will demand a premium for holding longer-term securities if they expect short-term rates to rise, which would reduce the present value of future cash flows. Therefore, the long-term rate must be higher than the current short-term rate to compensate for this risk.

The Expectations Theory Posits That