Question

4. Yield curve

(a) will have a downward slope if the inflation rate is expected to increase

(b) have been upward sloping during periods of high interest rates.

(c) are generally upward sloping.

(d) are plotted as real rather than nominal rates.

(e) have averaged a flat slope over time.

6. With the liquidity preference theory, a declining yield curve

(a) cannot be explained.

(b) follows the same forecasted spot rates as unbiased expectation.

(c) assumes no change in future interest rates.

(d) forecasts a steeper drop in future spot rates than the unbiased expectations.

(e) is really an increase in future rates due to the liquidity premium.

Answer 1

The question does not mention whether to choose the true value among the options or the false one. Also, no clarity on multiple answers.

Question 4

(a) A downward sloping yield curve denotes financial markets expects lower short term rates in future. Effects of inflation causes lateral shifts the yield curve. Thus, a downward sloping curve cannot point to inflation rates.

(b) During period of high interest rates, yield curve might be both upward or downward sloping depending upon the expected future interest rates.

(c) During specific period of monetary tightening in the history, yield curve has remained flat to downward sloping.

(d) As opposed to nominal rate, real rates are adjusted for inflation. Yield curves are real rates whereby inflation rates causes parallel or lateral shifts in curve.

(e) Slope of yield curve depends on expected interest rates in future and cannot be generalized to average to flat over time

Question 5

As per Liquidity Preference Theory, an investor demands a higher interest rate on securities with longer maturities which carry greater risk, because all other factors being equal, investors prefer cash or other highly liquid holdings. Thus, a downward yield curve, in light of liquidity preference theory, will predict further drop in rates in future.