2.4 Yield Curves

Question 1

An inverted yield curve, in which short-term rates are higher than long-term rates, will probably lead bond investors to

Answer 1

move some funds to short-term bonds to get the higher rates and keep other funds in long-term bonds to lock in rates for the long term.
Although short-term rates are attractive for investors, they will not last for a sustained period, because they represent an abnormal situation. Therefore, investors may allocate funds to longer-term bonds to lock in those rates for long periods as well as to generate capital gains when interest rates fall to a normal yield curve.

Question 2

A yield curve based on Treasury securities normally is upward sloping because

Answer 2

higher long-term rates reflect inflationary expectations.
Expectation about future inflation rates is one factor that leads investors to require higher rates of return for committing their funds for longer periods of time. In addition, long-term bonds usually have higher yields because of higher interest rate risk.

Question 3

yield curve theories

Answer 3

Unbiased expectations theory states that long-term rates consist of many short-term rates and that long-term rates will be the average of short-term rates.

The market segmentation theory relies on the laws of supply and demand for various maturities of borrowing and lending.

The liquidity preference theory holds that investors will pay a premium for shorter maturity bonds to avoid the higher interest rate risk associated with long-term bonds.

Question 4

unbiased expectations theory

Answer 4

The yield curve theory that states current long-term interest rates contain an implicit prediction of future short-term interest rates is known as

Question 5

If interest rates are expected to decrease in the near future, which of the following combinations of strategies is recommended?

Answer 5

Buy zero-coupon bonds

Buy bonds with longer maturities

Question 6

Yield curves are constructed from daily information published on U.S. Treasury bond

Answer 6

Yields-to-maturity represent a bond’s promised yield if held to maturity.

Question 7

liquidity preference theory

Answer 7

The interest rate theory that states investors are compensated for the increased price risk of holding long-term maturities

Question 8

interest rate risk

Answer 8

The risk associated with volatility in the price of securities due to shifts in the yield curve