The expectations theory of term structure suggests that the:
A) yield curve should be upward-sloping.
B) yield curve should be downward-sloping.
C) shape of the yield curve reflects the risk premium incorporated into the yields on long-term bonds.
D) shape of the yield curve depends on the expected future path of short-term interest rates.

Question

Quizplus · Accepted Answer

The expectations theory of term structure suggests that the shape of the yield curve depends on the expected future path of short-term interest rates. This means that if investors expect short-term rates to rise in the future, the yield curve will be upward-sloping, reflecting the higher yields required to compensate for the anticipated increase in rates. Conversely, if investors expect short-term rates to fall, the yield curve will be downward-sloping, as long-term yields will be lower due to the expected decrease in rates. The risk premium incorporated into long-term yields is not directly related to the expectations theory, although it can be a factor influencing the shape of the yield curve in practice.

The Expectations Theory of Term Structure Suggests That The