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IAI Actuarial Core Principles · Business Economics · Role of money and interest rates in the economy

According to the expectations theory of the term structure, an upward-sloping yield curve is most directly explained by which of the following?

Under the expectations theory, long rates reflect the average of expected future short rates, so an upward-sloping yield curve signals that investors expect short-term interest rates to rise. Expectations of falling rates would instead give a downward-sloping curve.

  1. AInvestors expect short-term interest rates to rise in futureCorrect
  2. BInvestors expect short-term interest rates to fall in future
  3. CInvestors are indifferent between all maturities because bonds are identical
  4. DCentral banks fix long-term rates above short-term rates
  5. Short-term bonds are less liquid than long-term bonds

Explanation

Under expectations theory, a long-term rate is an average of expected future short-term rates. If future short rates are expected to rise, the long rate exceeds the current short rate, producing an upward-sloping curve. Expected falls would produce a downward-sloping curve.

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