Question

If the expected path of 1-year interest rates over the next five years is 2 percent, 4 percent, 1 percent, 4 percent, and 3 percent, the expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of:_______.a. one year.
b. two years.
c. three years.
d. four years.

Answer 1

Answer:

.a. one year.

Explanation:

Expectation theory believes that the longer the maturity rate of a bond is the more interest it will generate, yet investing in two 1 year bonds may earn the same interest as one 2 year bond. Therefore in this scenario the bond with the lowest interest rate today is the one with a maturity of one year, due to it being the shortest bond to reach maturity.