Suppose the current one-year interest rate is 4%,and financial markets expect the one-year interest rate next year to be 8%.Given this information,the yield to maturity on a two-year bond will be approximately
A)4%.
B)6%.
C)8%.
D)12%.
E) none of the above

Question

Quizplus · Accepted Answer

Assuming the yield curve is upward sloping, we can use the expectation theory to estimate the yield to maturity on a two-year bond. According to this theory, the yield on a two-year bond is the average of the expected one-year rate in the first year and the expected one-year rate in the second year. In this case, the expected one-year rate in the first year is 4% and the expected one-year rate in the second year is 8%. Therefore, the yield to maturity on a two-year bond can be estimated as the average of these two rates, which is 6%.

Suppose the Current One-Year Interest Rate Is 4%,and Financial Markets