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ACCA Applied Skills · Financial Management · The valuation of debt and other financial assets

Which statement about an inverted yield curve is correct?

An inverted yield curve has short-term yields above long-term yields. Under the pure expectations theory this indicates that the market expects short-term interest rates to fall in future. A curve with higher long-term yields is normal, and identical yields describe a flat curve.

  1. AShort-term yields exceed long-term yields, which under pure expectations theory suggests that short-term rates are expected to fallCorrect
  2. BLong-term yields exceed short-term yields, indicating expected rate rises
  3. CYields are identical at all maturities, indicating no expected change in rates
  4. DYields on corporate bonds are below those on government bonds of the same maturity

Explanation

An inverted curve slopes downward: short-term yields are higher than long-term yields. Under pure expectations theory, this implies the market expects future short-term rates to fall. The upward-sloping description belongs to a normal curve and the flat description to a flat curve.

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