Question

EXPECTATIONS THEORY Assume that the real risk-free rate is 2% and that the maturity risk premium is zero. If a 1-year Treasury bond yield is 5% and a 2-year Treasury bond yields 7%, what is the 1-year interest rate that is expected for Year 2

Answer 1

9.04%

Step-by-step explanation:

We are to calculate this yield using a geometric average.

One year interest rate expected for year 2 = (1+r2)^2 / (1+r1) -1

One year interest rate expected for year 2 = (1+0.07)^2 / (1+0.05) -1

One year interest rate expected for year 2 = 1.0904 - 1

One year interest rate expected for year 2 = 0.0904

One year interest rate expected for year 2 = 9.04%