Which of the following statements is CORRECT?
A)If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the yield curve will have an upward slope.
B)If the maturity risk premium (MRP) is greater than zero, then the yield curve must have an upward slope.
C)Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.
D)If the maturity risk premium (MRP) equals zero, the yield curve must be flat.
E)The yield curve can never be downward sloping.

Question

Quizplus · Accepted Answer

As inflation is expected to increase in the future, the expected future interest rates would also increase. This would make long-term bonds less attractive as they would be locked into a lower interest rate for a longer period of time. Therefore, investors would demand a higher yield on long-term bonds, creating an upward sloping yield curve. The MRP being greater than zero would further increase the yield on long-term bonds. Option B is incorrect as the MRP being greater than zero does not necessarily mean that the yield curve must have an upward slope, it only suggests that long-term bonds would have a higher yield. Option C is incorrect as yields on long-term Treasury bonds can be lower than yields on short-term T-bonds if the market perceives short-term bonds to be riskier in the current economic environment. Option D is incorrect as the yield curve can be upward sloping or downward sloping even when the MRP is zero. Option E is incorrect as the yield curve can be downward sloping in certain economic conditions such as a recession or when the market expects future interest rates to decline.

Which of the Following Statements Is CORRECT