If one-year securities are yielding 5 percent, but the market anticipates that rates for one-year securities will rise to 7 percent, then according to the expectations theory, current two-year securities should be yielding
A) 12 percent.
B) 7 percent.
C) 6 percent.
D) 5 percent.

Question

Quizplus · Accepted Answer

According to the expectations theory, the yield on a long-term bond is the average of the yields on the short-term bonds expected to be issued over the life of the long-term bond. In this case, the market expects the yield on one-year securities to increase from 5 percent to 7 percent. Therefore, the expected yield on a two-year security would be the average of the current one-year yield (5 percent) and the expected one-year yield (7 percent), or (5% + 7%)/2 = 6 percent.

If One-Year Securities Are Yielding 5 Percent, but the Market