Skip to content

IAI Actuarial Core Principles · Economic Modelling · Models of the term structure of interest rates

Under the pure expectations theory of the term structure, an upward-sloping yield curve is interpreted as indicating that:

Under pure expectations theory, long-term yields equal averaged expected future short rates with no premium, so an upward-sloping curve means investors expect short-term rates to rise. Premiums for risk or segmentation belong to other theories.

  1. AInvestors expect short-term interest rates to rise in futureCorrect
  2. BInvestors demand compensation for holding long bonds because of price volatility
  3. CLong-dated bonds are in short supply relative to demand
  4. DInvestors are restricted to bonds matching their liability terms
  5. Short-term rates will remain constant while risk premiums rise

Explanation

Pure expectations theory says long yields are an average of expected future short rates, with no risk premium. A rising curve therefore implies expected rises in short rates. Liquidity premium and market segmentation explanations are separate theories.

Did you get it right without looking?

One question tells you little. A timed set on Models of the term structure of interest rates shows your real accuracy, how long you take and where you lose marks.

Practise Models of the term structure of interest ratesFree diagnostic mock

More Models of the term structure of interest rates questions