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

According to the Expectations Hypothesis, market forces will result in long-term interest rates being equal to the average of the current and expected short-term rates. This implies that bonds of different maturities are perfect substitutes because their yields are determined by the same underlying factors (current and expected short-term rates), effectively making them interchangeable.

Under the Expectations Hypothesis, Bonds of Different Maturities Are Assumed