Question #31
Reading: Reading 25 The Term Structure and Interest Rate Dynamics
PDF File: Reading 25 The Term Structure and Interest Rate Dynamics.pdf
Page: 11
Status: Correct
Correct Answer: A
Question
According to the pure expectations theory, which of the following statements is most accurate? Forward rates:
Answer Choices:
A. are biased estimates of market expectations
B. always overestimate future spot rates
Explanation
The pure expectations theory, also referred to as the unbiased expectations theory,
purports that forward rates are solely a function of expected future spot rates. Under the
pure expectations theory, a yield curve that is upward (downward) sloping, means that
short-term rates are expected to rise (fall). A flat yield curve implies that the market
expects short-term rates to remain constant.