Assume that the expectations theory holds,and that liquidity and maturity risk premiums are zero.If the annual rate of interest on a 2-year Treasury bond is 10.5 percent and the rate on a 1-year Treasury bond is 12 percent,what rate of interest should you expect on a 1-year Treasury bond one year from now?
A) 9.0%
B) 9.5%
C) 10.0%
D) 10.5%
E) 11.0%

Question

Quizplus · Accepted Answer

According to the expectations theory, the interest rate on a 2-year bond is the average of the current 1-year rate and the expected 1-year rate one year from now. Thus, (12% + x)/2 = 10.5%, solving for x gives x = 9.0%.

Assume That the Expectations Theory Holds,and That Liquidity and Maturity