Question

The implication of the expectations theory that expected returns for a holding period must be the same for financial instruments of different maturities depends on the assumption that:__.

Answer 1

The implication of the expectations theory that expected returns for a holding period must be the same for financial instruments of different maturities depends on the assumption that instruments with different maturities are perfect substitutes.

By assuming that there is no chance for arbitrage, expectations theory aims to forecast short-term interest rates based on existing long-term rates by stating that two investment strategies with similar time horizons should produce equal returns.

It helps investors predict future interest rates and aids in helping them make investment decisions. Depending on the results of the expectancies theory, investors can determine whether or not future interest rates are advantageous for investing. Government bond rates are utilized as long-term rates in principle, which aids analysts in predicting short-term rates and predicting where these short-term rates will trade in the future.

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