Assume that the real risk-free rate is 1% and that the maturity risk premium is zero. If a 1-year Treasury bond yield is 7% and a 2-year Treasury bond yields 8%, what is the 1-year interest rate that is expected for Year 2? Calculate this yield using a geometric average. Do not round intermediate calculations. Round your answer to two decimal places.

Answer: the 1-year interest rate that is expected for year 2 is 7.5%

Explanation:

using geometric average to calculate the yield as follows

the formula for geometric average is given as: gm = (r1 + r2) ∧1/nth, where

gm represent geometric average, r1 represent year 1 rate of interest or yield=7%, r2 represent year 2 interest rate or yield = 8%, n represent number of years, and ∧ represent raise to power

gm = (1.07 + 0.08) ∧1/2 = 1.075 = 7.5%