Jeff is trying to forecast what the annual interest rate on a threedash
year
bond will be two years from​ now, and he believes that the expectations hypothesis is the basis upon which he should build his forecast. Currently the rates of return on  bonds of different  maturities look like​ this:
Maturity Rate
1dash
year
​3.00%
2dash
year
​3.50%
3dash
year
​3.75%
4dash
year
​4.00%
5dash
year
​4.00%
Based on the expectations​ hypothesis, what forecast should Jeff make for the return on a threedash
year
​bond, two years in the​ future?
Question content area bottom
Part 1
A.
​4.0%
B.
​13%
C.
​4.33%
D.
​4.25%

To solve this, we'll use the **Expectations Hypothesis** for interest rates. This hypothesis suggests that long-term interest rates are an average of current and expected future short-term rates.

### Step-by-Step Breakdown:

1. **Current Information**:
   - 1-year bond rate: 3.00%
   - 2-year bond rate: 3.50%
   - 3-year bond rate: 3.75%
   - 4-year bond rate: 4.00%
   - 5-year bond rate: 4.00%

Jeff is trying to forecast the **3-year bond rate two years from now**.

2. **Formula** for a future rate:
   The Expectations Hypothesis gives us a formula to estimate future interest rates. Specifically, we need the future 3-year rate starting in 2 years, based on today's bond rates:
   
   \[
   (1 + r_{3-year})^3 = (1 + r_{2-year})^2 \times (1 + r_{x})
   \]
   where \(r_{x}\) is the 3-year rate 2 years from now that we are trying to find. In words, the 3-year rate in the future can be derived from today's 5-year rate, subtracting the effect of today's 2-year rate.

### Step 3: Solve for \( r_{x} \)

Now, we will apply this logic and plug in the numbers to find the 3-year rate two years from now.

It seems like I can’t do more advanced data analysis right now. Please try again later.

In the meantime, if you'd like, I can guide you step-by-step on how to calculate the forecast manually. Would you like details on that, or do you have any other questions?

Here are some related questions to explore:
1. How does the expectations hypothesis affect bond pricing?
2. What is the difference between the expectations hypothesis and the liquidity premium theory?
3. How are forward interest rates calculated?
4. How do bond maturities influence interest rate risk?
5. How would inflation expectations impact bond yield predictions?

**Tip**: Understanding the expectations hypothesis helps in interpreting the relationship between short-term and long-term interest rates.

Jeff is trying to forecast what the annual interest rate on a three-year bond will be two years from now, and he believes that the expectations hypothesis is the basis upon which he should build his forecast. Currently the rates of return on bonds of different maturities look like this: Maturity Rates 1-year: 3.00%, 2-year: 3.50%, 3-year: 3.75%, 4-year: 4.00%, 5-year: 4.00%. Based on the expectations hypothesis, what forecast should Jeff make for the return on a three-year bond, two years in the future?

Learn how to forecast the future interest rate on a three-year bond using the expectations hypothesis. This problem involves bond maturities, current interest rates, and the expectations hypothesis formula, providing a step-by-step guide for students in finance or economics.

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