The expectations theory suggests that
A) the yield curve should usually be upward-sloping.
B) the yield curve should usually be downward-sloping.
C) the slope of the yield curve depends on the expected future path of short-term rates.
D) the slope of the yield curve reflects the risk premium incorporated into the yields on long-term bonds.

Question

Quizplus · Accepted Answer

The expectations theory suggests that the slope of the yield curve depends on the expected future path of short-term rates. Essentially, if investors expect short-term rates to rise in the future, long-term rates will also rise to compensate for the added uncertainty and risk. This results in a steep upward slope of the yield curve. On the other hand, if investors expect short-term rates to remain low or decline in the future, long-term rates will also be lower, resulting in a flatter yield curve.

The Expectations Theory Suggests That