One-year interest rates are 3 percent. The market expects one-year rates to be 5 percent one year from now. The market also expects one-year rates to be 7 percent two years from now. Assume that the unbiased expectations theory holds. Which of the following is correct?

Question

Quizplus · Accepted Answer

The unbiased expectations theory suggests that the yield curve reflects market expectations for future short-term rates. Given that interest rates are expected to rise from 3% to 5% and then to 7% over the next two years, the yield curve would be upward sloping, indicating increasing interest rates over time.

One-Year Interest Rates Are 3 Percent