Under the expectations hypothesis, bonds of different maturities are assumed to be perfect substitutes because:
A) the risk premium is assumed to be negative.
B) market forces would always have long-term interest rates equal the average of the current and expected short-term rate.
C) expectations of future interest rates are uncertain and therefore cannot be included in the analysis.
D) bond markets are very liquid.

Question

Quizplus · Accepted Answer

The expectations hypothesis assumes that market forces will result in long-term interest rates being equal to the average of the current and expected short-term rate. This implies that bonds of different maturities are perfect substitutes, as their yields would be based solely on expectations of future short-term interest rates.

Under the Expectations Hypothesis, Bonds of Different Maturities Are Assumed