If 1-year interest rates for the next three years are expected to be 4,2,and 3 percent,and the 3-year term premium is 1 percent,than the 3-year bond rate will be
A) 1 percent.
B) 2 percent.
C) 3 percent.
D) 4 percent.

Question

Quizplus · Accepted Answer

The 3-year bond rate is calculated by averaging the expected 1-year interest rates over the three years (4%, 2%, and 3%) and adding the term premium of 1%. The average of the rates is (4 + 2 + 3) / 3 = 3%. Adding the 1% term premium results in a 3-year bond rate of 4%.

If 1-Year Interest Rates for the Next Three Years Are