Which of the following statements is CORRECT?
A) If the maturity risk premium (MRP) is greater than zero, then the yield curve must have an upward slope.
B) Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.
C) If the maturity risk premium (MRP) equals zero, the yield curve must be flat.
D) The yield curve can never be downward sloping.
E) If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the yield curve will have an upward slope.

Question

Quizplus · Accepted Answer

The statement E is correct. If inflation is expected to increase in the future, investors will demand higher nominal yields to compensate for the expected loss of purchasing power. This will lead to an increase in long-term interest rates, resulting in an upward sloping yield curve. The maturity risk premium (MRP) reflects the added compensation that investors demand for holding longer-term bonds due to the greater interest rate risk. If MRP is greater than zero, this means that long-term rates are higher than short-term rates, which further reinforces the upward slope of the yield curve.

Which of the Following Statements Is CORRECT