According to the expectations theory of the term structure of interest,if the 1-year bond rate today is 7% p.a.and the 1-year bond rate in one year's time is 9% p.a. ,what is 2-year bond rate today?
A)6%
B)7.5%
C)8%
D)10%

Question

Quizplus · Accepted Answer

According to the expectations theory, long-term bond rates can be estimated as the average of expected future short-term rates. In this case, the expected 1-year rate next year is 9%, so the expected rate for year two is also 9%. Thus, the average of the expected 1-year rates for years one and two is (7%+9%)/2 = 8%. Therefore, the 2-year bond rate today is 8%.

According to the Expectations Theory of the Term Structure of Interest,if