Assume the Expectation Hypothesis regarding the term structure of interest rates is correct. Then, if the current one-year interest rate is 4% and the two-year interest rate is 6%, then investors are expecting:
A) The future one-year rate to be 4%
B) The future one-year rate to be 8%
C) The future one-year rate to be 6%
D) The future one-year rate to be 5%

Question

Quizplus · Accepted Answer

According to the Expectation Hypothesis, the two-year rate is the average of the current one-year rate and the expected future one-year rate. Therefore, (4% + x)/2 = 6%, solving for x gives x = 8%.

Assume the Expectation Hypothesis Regarding the Term Structure of Interest