According to the expectations theory of the term structure,
A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future.
B) when the yield curve is downward-sloping, short-term interest rates are expected to decline in the future.
C) buyers of bonds prefer short-term to long-term bonds.
D) all of the above.
E) only A and B of the above.

Question

Quizplus · Accepted Answer

According to the expectations theory, the shape of the yield curve reflects market expectations about future short-term interest rates. When the yield curve is upward-sloping, the market expects short-term interest rates to rise, which drives up long-term bond yields. Conversely, when the yield curve is downward-sloping, the market expects short-term interest rates to decline, which depresses long-term bond yields. The theory does not make any statement about buyer preferences for short-term or long-term bonds. Therefore, options A and B are correct, and option C is incorrect. Thus, the best choice is E.

According to the Expectations Theory of the Term Structure