A One-Year Bond Currently Pays 5% Interest

question 93

Multiple Choice

A one-year bond currently pays 5% interest. It's expected that it will pay 4.5% next year and 4% the following year. The two-year term premium is 0.2% while the three-year term premium is 0.35%. What is the interest rate on a two-year bond according to the preferred habitat theory?

• A)4.5%
• B)4.75%
• C)4.95%
• D)4.975%

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Definitions:

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Money Market Mutual Funds

Investment funds that invest in short-term debt securities, providing investors with high liquidity and a relatively safe investment.

Eurodollars

Deposits held in U.S. dollars at banks outside the United States, used in international transactions and considered an important part of the global money market.