## Bond Valuation- Quiz 1

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

### Bond Valuation- Quiz 1

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?

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.

edupristine
Finance Junkie
Posts: 947
Joined: Wed Apr 09, 2014 6:28 am

### Re: Bond Valuation- Quiz 1

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

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?

edupristine
Finance Junkie
Posts: 947
Joined: Wed Apr 09, 2014 6:28 am

### Re: Bond Valuation- Quiz 1

Pure expectations theory is mainly an estimation of short-term interest rates. An upward sloping yield-curve as per Pure expections theory means that, the short term (0-2 years) rates are going to increase. With the yield curve already quoting higher rates for medium term (3-5 years), the increase in short term rates would result in flattening of the yield curve for say 0-5 years.