According to the expectations hypothesis, if investors believed that, for a given holding period, the average of the expected future short-term yields was greater than the long-term yield for the holding period, they would act so as to drive:
A) down the price of the short-term bond and drive up the price of the long-term bond.
B) up the price of the short-term bond and drive down the price of the long-term bond.
C) up the prices of both the short- and long-term bonds.
D) down the prices of both the short- and long-term bonds.

Question

Quizplus · Accepted Answer

According to the expectations hypothesis, if investors believe that future short-term yields will be higher than the current long-term yield, they will prefer to invest in short-term securities which offer higher returns. This preference will drive up the price of short-term securities and push down the price of long-term bonds, resulting in higher short-term yields and lower long-term yields in the future. Therefore, the correct answer is (B) up the price of the short-term bond and drive down the price of the long-term bond.

According to the Expectations Hypothesis, If Investors Believed That, for a Given