Which of the following combinations will result in a sharply-increasing yield curve?
A)Increasing future expected short rates and increasing liquidity premiums
B)Decreasing future expected short rates and increasing liquidity premiums
C)Increasing future expected short rates and decreasing liquidity premiums
D)Increasing future expected short rates and constant liquidity premiums

Question

Quizplus · Accepted Answer

A combination of increasing future expected short rates and increasing liquidity premiums will result in a sharply-increasing yield curve. When future expected short rates increase, longer-term bonds become less attractive, leading to higher yields to compensate for the increased risk. When liquidity premiums increase, investors demand a higher return for holding less liquid assets, which also results in higher yields. This combination creates a steeper yield curve, with bigger differences between short-term and long-term bond yields.

Which of the Following Combinations Will Result in a Sharply-Increasing