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Why is the risk equivalent (or risk adjusted) spot rate less than the actual spot rate?...

Why is the risk equivalent (or risk adjusted) spot rate less than the actual spot rate? Keeping in mind the expectations theory of term structure.

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As per the Expectation theory of term structure, return in 02 years bond will be equivalent return in 01 Years Bond and after 01 Year reinvesting the same in a 01-year bond.

But in actual market, think about the Risk in holding longer maturity bonds will be higher than holding shorter maturity bonds. So Return will be comparatively Higher for longer maturity bonds. To make longer maturity bonds more attractive its risk equivalent rate makes higher than shorter maturity bonds.

If this rate is not made higher every investor will invest in 01 years bond and after maturing 01 years bond reinvest the same in another 01-year bond. As holding shorter maturity bonds is less risky.

X Return in 02 Year Maturity X2 X Return in 01 Year Maturity X1 Return in 01 Year Maturity X2

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