If the expected path of one-year interest rates over the next five years is 2 percent,4 percent,1 percent,4 percent,and 3 percent,then the pure expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of
A) one year.
B) two years.
C) three years.
D) four years.

Question

Quizplus · Accepted Answer

According to the pure expectations theory, the interest rate on a bond is determined by the average of expected future short-term interest rates. The one-year bond will have the lowest interest rate today because it reflects only the first year's expected rate of 2 percent, which is the lowest among the given rates.

If the Expected Path of One-Year Interest Rates Over the Next