Based on the Pure Expectations Theory of interest rates, if the one-year rate is 4%, and...
Based on the Pure Expectations Theory of interest rates, if the one-year rate is 4%, and the one-year rate, one year from now, is expected to be 10%, the current two-year rate should be
Select one:
a. 7.0 %
b. 3.0%
c. 6.0%
d. 14.0%
Homework Answers
Based on Pure Expectations Theory,
(1 + 2 Yr rate)2 = (1 + 1 Yr Rate) * (1 + 1 Yr Rate 1 Yr from now)
(1 + 2 Yr rate)2 = (1 + 4%) * (1 + 10%)
(1 + 2 Yr rate)2 = 1.04 * 1.10
(1 + 2 Yr rate)2 = 1.144
(1 + 2 Yr rate) = 1.0696
2 Yr Rate = 0.0696
2 Yr Rate = 6.96% = 7.0% (Option a)
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