Question

If the maturity risk premium were zero, what would the relationship be between future short-term, current short-term, and long-term rate?

Answer 1

Explanation :

Expectation theory:

At zero rate,

This theory explains the hypothesis of term structure of interest rate to the term maturity of a bond.It states that long term interest rate should be equal to average of short term interest rates.

Let R1 be the interest rate of future short term debt

Let R2 be the interest rate of current short term debt

Let R3 be the interest rate of long term debt

Then the relationship between the three shall be

(1+R3)(1+R3)=(1+R1)(1+R2).

Condition:: there shall be no arbitrage opportunity.