Under the preferred habitat theory the shape of the yield curve depends on
A)the relative return of investments in common stocks versus investments in corporate bonds.
B)the size of the federal government's budget deficit.
C)government tax treatment of long-term versus short-term bonds.
D)the expected pattern of future short-term rates and the size of the term premium at each maturity.

Question

Quizplus · Accepted Answer

According to the preferred habitat theory, the shape of the yield curve is determined by the expectations of future short-term interest rates and the size of the term premium at each maturity. Investors may have a preferred investment horizon, and they may require an extra yield (term premium) to invest in longer-term bonds to compensate for the additional risk. This can result in a steeper or flatter yield curve depending on the relationship between short-term rates and the term premium at each maturity.

Under the Preferred Habitat Theory the Shape of the Yield