The Current Interest Rate on a One-Year Bond Is 4

question 5

Multiple Choice

The current interest rate on a one-year bond is 4 percent and the current rate on a two-year bond is 4.4 percent. If the expectations theory of the term structure is correct, what is the one-year interest rate expected during Year 2? That is, compute the rate that is expected to exist only during Year 2. (Base your answer on an arithmetic average rather than a geometric average.)

• A)4.8%
• B)4.2%
• C)4.4%
• D)0.4%
• E)8.4%

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