According to expectations theory if the 1 year interest is 2.5% this year and expected to be 3.5% next year, the 2 year interest rate should be approximately
A) 8.75%.
B) 6%.
C) 3.5%.
D) 3%.

Question

Quizplus · Accepted Answer

The expectations theory suggests that the 2-year interest rate is the average of the current 1-year rate and the expected 1-year rate next year. Thus, (2.5% + 3.5%) / 2 = 3%.

According to Expectations Theory If the 1 Year Interest Is