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 5 years.
Explanation:
The term structure of interest rates is the relationship between interest rates or bond yields and different terms or maturities. In a graph, the term structure of interest rates is known as yield curve, and plays a crucial role in identifying the current state of an economy.
The interest rates and yields on credit market instruments of the same maturity vary because of differences in default risk, liquidity, information costs and taxation.
