If the expectations theory of the term structure of interest rates is correct, and if the other term structure theories are invalid, and we observe a downward sloping yield curve, which of the following is a true statement?

Question

Quizplus · Accepted Answer

The expectations theory states that long-term interest rates are determined by the market’s expectations of future short-term interest rates. If the yield curve is downward sloping, it suggests that investors expect interest rates to decrease in the future. This is consistent with the expectations theory, where short-term rates are expected to fall, leading to lower long-term rates. Thus, choice C is the correct answer. Choices A, B, D, and E are incorrect because they do not explain the observed downward sloping yield curve.

If the Expectations Theory of the Term Structure of Interest