Interest rates on 1-year, 2-year, and 3-year Treasury bills are 5%, 6%, and 7% respectively. Assume that the pure expectations theory holds and that the market is in equilibrium. Which of the following statements is correct?

Question

Quizplus · Accepted Answer

According to the pure expectations theory, the interest rate on a long-term bond is an average of the short-term interest rates that people expect to occur over the life of the long-term bond. Given the rates, the market expects the one-year rate to be 7% one year from today to make the average rate for the 2-year bond 6%.

Interest Rates on 1-Year, 2-Year, and 3-Year Treasury Bills Are