Understanding the Expectations Theory of Interest Rates

Easy Fixed Income Valuation Term Structure Of Interest Rates

The term structure of interest rates is an essential concept in fixed income valuation. It reflects how interest rates vary with the maturity dates of debt instruments. A key theory that explains this relationship is the expectations theory, which suggests that long-term rates reflect the market's expectations of future short-term rates.

Which of the following statements accurately describes the implications of the expectations theory regarding the term structure of interest rates?

The expectations theory indicates that the yield curve will be upward sloping when future short-term interest rates are expected to decline.

According to the expectations theory, a flat yield curve implies that future short-term interest rates are expected to remain constant.

The expectations theory suggests that a downward sloping yield curve indicates that future short-term interest rates are expected to rise.

Hint

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