Assume the current interest rate on a one-year bond is 7%,and the interest rate investors expect on the one-year bond one year from now is 3%.According to the expectations hypothesis,the current interest rate (per year)on a two-year bond should be

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According to the expectations hypothesis, the current interest rate on a two-year bond is the average of the expected future interest rates over the two-year period. Therefore, the current interest rate on a two-year bond should be [(7% + 3%)/2] = 5%. Therefore, the best choice is B.

Assume the Current Interest Rate on a One-Year Bond Is