Skip to content

ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against interest rate risk

The yield curve is steeply upward sloping. A company with a floating-rate loan is considering swapping into fixed rate. According to the expectations theory of the term structure, what does the upward slope imply?

Under expectations theory, an upward-sloping yield curve means the market expects short-term interest rates to rise. Long-term yields reflect the average of expected future short-term rates, so higher long yields signal anticipated increases in short rates.

  1. AThe market expects short-term interest rates to rise in futureCorrect
  2. BThe market expects short-term interest rates to fall in future
  3. CInvestors demand no premium for holding long-term bonds
  4. DLong-term bonds are always less risky than short-term bonds

Explanation

Under the expectations theory, long-term rates are the average of expected future short rates, so an upward slope implies rising expected short rates. Falling rates would produce a downward slope. The statement about no premium is not an implication, and long bonds carry more price risk.

Did you get it right without looking?

One question tells you little. A timed set on The use of financial derivatives to hedge against interest rate risk shows your real accuracy, how long you take and where you lose marks.

Practise The use of financial derivatives to hedge against interest rate riskFree diagnostic mock

More The use of financial derivatives to hedge against interest rate risk questions