The Current Interest Rate on a One-Year Bond Is 4

Multiple Choice

The current interest rate on a one-year bond is 4 percent and the current rate on a two-year bond is 4.4 percent. If the expectations theory of the term structure is correct, what is the one-year interest rate expected during Year 2? That is, compute the rate that is expected to exist only during Year 2. (Base your answer on an arithmetic average rather than a geometric average.)

A) 4.8%
B) 4.2%
C) 4.4%
D) 0.4%
E) 8.4%