Consider the following two strategies for moving money from a given moment to two years later: (i) buying a one-year bond and then buying another one-year bond the following year and (ii) buying a two-year bond. Assume that historically these two strategies have had the same yield on average. Furthermore, assume that the yield on a one-year bond bought today is 1 percent and the yield on a two-year bond bought today is 3 percent. Let X denote the expected yield of a one-year bond bought next year according to the expectations hypothesis. Let Y denote the expected yield of a one-year bond bought next year according to the empirical data. X equals how many percent? Is Y larger than X, smaller than X, or equal to X? (Ignore any compounding in your calculations.)
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