The expectations theory suggests that
A)the yield curve should normally be upward-sloping.
B)the yield curve should normally be downward-sloping.
C)the slope of the yield curve depends on the expected future path of short-term rates.
D)the slope of the yield curve reflects the risk premium incorporated into the yields on long-term bonds.

Question

Quizplus · Accepted Answer

The expectations theory suggests that the slope of the yield curve depends on the expected future path of short-term rates. In other words, if investors expect short-term rates to rise in the future, the yield curve will be upward-sloping to compensate for this expectation. Conversely, if investors expect short-term rates to fall in the future, the yield curve will be downward-sloping. The theory assumes that all bonds have the same risk and liquidity characteristics, so it does not incorporate a risk premium into long-term bond yields.

The Expectations Theory Suggests That