Suppose the economy has an inverted yield curve.According to the Expectations Hypothesis, which of the following interpretations could be used to explain this?
A)Interest rates are expected to fall in the future.
B)Investors prefer bonds with less default risk.
C)Investors prefer bonds with less interest-rate risk.
D)The term spread is positive.

Question

Quizplus · Accepted Answer

The Expectations Hypothesis suggests that long-term interest rates reflect the expected future short-term interest rates. An inverted yield curve implies that the market participants expect interest rates to fall in the future, which leads to a higher demand for long-term bonds and results in lower yields on long-term bonds compared to short-term bonds. Therefore, choice A is the best answer. Choices B, C, and D are not related to the Expectations Hypothesis.

Suppose the Economy Has an Inverted Yield Curve