Bond Valuation- Quiz 1

vaishnevis
Posts: 3
Joined: Sat May 13, 2017 8:15 am

Bond Valuation- Quiz 1

Postby vaishnevis » Mon Jun 26, 2017 9:18 am

According to the pure expectations hypothesis, which of the following statement is correct concerning the expectations of market participants in an upward sloping yield curve environment?


Choose one answer.

a. Interest rates will decrease and the yield curve will flatten Incorrect
b. Interest rates will decrease and the yield curve will steepen. Incorrect
c. Interest rates will increase and the yield curve will flatten. Correct
d. Interest rates will increase and the yield curve will steepen. Incorrect
.
The correct answer is : C: interest rates will increase and the yield curve will flatten.
The pure expectations hypothesis implies that the slope of the yield curve indicates the market expectations for the direction of change of future short term interest rates. Hence, an upward sloping yield curve would suggest interest rates will increase and the yield curve will flatten.

-->Could you please help understand how increate in interest rates cause a flattening of yield curve?

edupristine
Finance Junkie
Posts: 780
Joined: Wed Apr 09, 2014 6:28 am

Re: Bond Valuation- Quiz 1

Postby edupristine » Fri Jul 21, 2017 9:40 am

An upward sloping yield curve would suggest that interest rates will increase and the yield curve will flatten. Hence, the pure expectations hypothesis implies that the slope of the yield curve indicates the market's expectation for the direction of change of future short term interest rates.

vaishnevis
Posts: 3
Joined: Sat May 13, 2017 8:15 am

Re: Bond Valuation- Quiz 1

Postby vaishnevis » Fri Jul 28, 2017 11:36 am

Hi, Sorry didn't understand.

As per pure expectations theory say 2 year interest rates are a geometric mean of interest rates of two periods (0 to 1 and 1 to 2). In this case if short term interest rates increase say from 0 to 1 and 1 to 2, this should increase the long term(2 year) interest rates too? How does this cause a flattening in yield curves?


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