Chapter 6, Problem 15P

Summary Introduction

To analyze: The expected interest rate for year 2, yield, expected inflation rate during year 2 and the reason of the difference between the average interest rate during 2-year period and 1-year period for the year 2.

Introduction:

Expectation Theory:

Expectation theory estimates the future interest without taking into consideration of maturity risk. According to the expectation theory, the yield curve of investment is totally depending upon the future expectation of investors.