Question #23 - Reading 25 The Term Structure and Interest Rate Dynamics

Reading: Reading 25 The Term Structure and Interest Rate Dynamics

PDF File: Reading 25 The Term Structure and Interest Rate Dynamics.pdf

Page: 9

Status: Correct

Correct Answer: A

Shared Context

- Wallace now poses a similar question regarding the liquidity preference theory. Which of the following could explain an upward sloping yield curve according to the liquidity preference theory of the term structure of interest rates? A) There is a risk premium associated with more distant maturities. B) The market expects short-term rates to rise through the relevant future. C) There is greater demand for short-term securities than for long-term securities.

Question

Wallace completes his first lecture by tying the relationship between Treasury prices and the shape of the term structure. He is particularly interested in the implications of a steepening yield curve. Which of the following is most accurate for a steepening yield curve?

Answer Choices:

A. The price of short-term Treasury securities increases relative to the price of long- term Treasury securities

B. The price of long-term Treasury securities increases relative to the price of short- term Treasury securities

C. The price of short-term Treasury securities increases

Explanation

For a steepening of the yield curve to occur, in every case, the short-term yield has to decrease relative to the long-term yield. Therefore, the price of short-term Treasury securities increases relative to the price of long-term securities.

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