Question

Assume the Expectations Hypothesis regarding the term structure of interest rates is correct.

If the current one-year interest rate is 2% and the expected one-year interest rate is 3%, then the current two-year interest rate should be ___%.

Answer 1

2.5% is the current two years interest rate

Step-by-step explanation:

If the first year interest rate is 2% and expected coming year interest rate is 3% based on the hypothetical projection which is believed to be correct, then the interests rate for the two years will be the average of the interest of the two years in focus which gives us:

Current IR = IR (yr 1) + IR (yr 2) / no of years

Current IR = 2 + 3 / 2 = 2.5