If the expected path of one-year interest rates over the next four years is 5 percent,4 percent,2 percent,and 1 percent,then the pure expectations theory predicts that today's interest rate on the four-year bond is
A) 1 percent.
B) 2 percent.
C) 4 percent.
D) none of the above.

Question

Quizplus · Accepted Answer

The pure expectations theory suggests that the interest rate on a long-term bond will equal the average of the short-term interest rates that people expect to occur over the life of the long-term bond. In this case, the average of the expected one-year interest rates over the next four years (5%, 4%, 2%, 1%) is (5+4+2+1)/4 = 3%. Since none of the provided options matches this calculation, the correct answer is D) none of the above.

If the Expected Path of One-Year Interest Rates Over the Next