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ACCA Applied Skills · Financial Management · Causes of exchange rate differences and interest rate fluctuations

According to the expectations theory of interest rates, what is a upward-sloping yield curve evidence of?

An upward-sloping yield curve indicates that investors expect short-term interest rates to rise in future. Under expectations theory, long-term yields reflect the average of expected future short-term rates, so higher long-term yields signal anticipated increases.

  1. AInvestors expect short-term interest rates to rise in the futureCorrect
  2. BInvestors prefer short-term securities and require no extra return for lending long-term
  3. CInvestors expect short-term interest rates to fall in the future
  4. DGovernment demand for long-term borrowing has fallen

Explanation

Expectations theory says long-term rates are the average of expected future short-term rates. An upward-sloping curve therefore indicates that markets expect short-term rates to rise. A downward-sloping curve would imply expected falls.

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