Question

In April 2004, the US economy was struggling to get out of a recession (jobless recovery), but investors were confident that the economy would recover soon and that the Fed would raise the short-term interest rate. According to the expectations hypothesis what kind of the yield curve typically arises in such a period:

Select one:

a.

A hump-shaped yield curve

b.

A downward slopping yield curve

c.

An upward sloping yield curve

d.

A flat yield curve

Answer 1

If the short term interest rates were to raise, then that would result in a downward sloping yield curve. Option b is correct.

A yield curve is a plot of interest rates for different maturities of the treasury bonds.

Option c is incorrect because an upward sloping yield curve happens when the short term interest rates are lowered.

Options d is incorrect because the slope of the yield curve will change.

Option a is incorrect because typically the slope of the yield curve is linear.

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