Assume the Expectations Hypothesis regarding the term structure of interest rates is correct.Then, if the current two-year interest rate is 5% and the current one-year rate is 6%, then investors expect the future one-year rate to be:
A)4%.
B)5%.
C)6%.
D)1%.

Question

Quizplus · Accepted Answer

According to the Expectations Hypothesis, the two-year interest rate is the average of the current one-year rate and the expected future one-year rate. Thus, (6% + expected future rate) / 2 = 5%, leading to an expected future rate of 4%.

Assume the Expectations Hypothesis Regarding the Term Structure of Interest