According to the expectations theory, if the 1-year rate is 2.5% and the 2-year rate is 3.64%, the expected 1-year rate would be
A) 3.80%.
B) 4.80%.
C) 5.80%.
D) 6.80%.

Question

Quizplus · Accepted Answer

The expectations theory suggests that the future short-term interest rates can be inferred from the current long-term rates. Using the formula for the expectations theory: (1 + 2-year rate)^2 = (1 + 1-year rate) * (1 + expected 1-year rate). Solving for the expected 1-year rate gives approximately 4.80%.

According to the Expectations Theory, If the 1-Year Rate Is