The following are the expected one-year T-bill rates for the next four years: 3%, 4%, 5%, and 6%. According to the basic model of the expectations hypothesis, what would you expect the rate for three-year securities to be?

12%

Explanation:

If the following are the expected one-year T-bill rates for the next four years: 3%, 4%, 5%, and 6%.

According to the basic model of the expectations hypothesis, the expected rate for three-year securities will be 3% + 4% + 5% = 12%

The theory of the basic model of the expectations hypothesis suggests that an investor earns the same amount of interest by investing in three consecutive one-year bond investments versus investing in one three-year bond today. The theory is also known as the "unbiased expectations theory."

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