Question

“According to the expectations theory of the term structure, it is better to invest in one-year bonds, reinvested over two years, than to invest in a two-year bond if interest rates on one-year bonds are expected to be the same in both years.” Is this statement true, false, or uncertain?

Short answer

Based on this definition, it is possible to conclude that the given statement is false.

Step-by-step solution

Definition

The expectation theory can be defined as the interest rate o a long-term bond will be equal to an average of the short-term interest rates that are expected to occur over life.

Explanation

The given statement is said to be false because the two-year term bond would have the same interest rate as the average of the one-year bonds. Since the interest rates on one-year bonds are expected to be the same in both years, for example, $5\%$, then the two-year bond would have an interest rate of $5\%$. This would make both of the investment choices equally as appealing. Therefore, it is not better to invest in one over the other based on the expectation theory of the term structure.