The expectations hypothesis suggests the:
A) yield curve should usually be downward sloping.
B) yield curve should usually be upward sloping.
C) slope of the yield curve reflects the risk premium associated with longer-term bonds.
D) slope of the yield curve depends on the expectations for future short-term rates.

Question

Quizplus · Accepted Answer

The expectations hypothesis suggests that the slope of the yield curve depends on the expectations for future short-term rates. In other words, if investors expect short-term rates to rise in the future, long-term bond yields will also rise, resulting in an upward sloping yield curve. Conversely, if investors expect short-term rates to fall in the future, long-term bond yields will also fall, resulting in a downward sloping yield curve. Therefore, option D is the correct answer.

The Expectations Hypothesis Suggests The