What happens to the shape of the yield curve if expectations about future interest rates change such that future short term interest rates are expected to be lower than previously expected?
A)the slope (shape) of the yield curve remains the same but the curve shifts down.
B)the differences among various yield curves narrows.
C)If positively sloped, the yield curve becomes flatter; if negatively sloped, the yield curve becomes more negatively sloped.
D)Both a and b are correct.

Question

Quizplus · Accepted Answer

When expectations about future short-term interest rates shift to anticipate lower rates than previously expected, the yield curve adjusts its slope accordingly. If the curve was initially positively sloped (indicating higher future rates), it becomes flatter as the expectation of lower future rates reduces the upward slope. Conversely, if the curve was negatively sloped (indicating lower future rates), expecting even lower future rates would exaggerate this slope, making the curve more negatively sloped. This adjustment reflects the market's anticipation of future interest rates across different maturities.

What Happens to the Shape of the Yield Curve If