Asked by Morris Mwendwa on Jun 20, 2024
Verified
The term structure of interest rates may be downward sloping if:
A) The interest rate risk premium is the same for both short and long-term bonds.
B) The inflation premium decreases with maturity.
C) The real rate of interest is lower this year than it was last year.
D) Default risk premiums are higher for longer term bonds than for shorter term bonds.
E) There are bonds that have an unfavourable tax status.
Term Structure
A concept that describes the relationship between the yields of long-term and short-term bonds, typically indicating future interest rate movements.
Interest Rates
Interest rates signify the cost of borrowing money, typically expressed as a percentage of the principal amount loaned.
Inflation Premium
The portion of investment returns that compensates investors for the loss of purchasing power due to inflation.
- Examine the configuration of interest rates over time and its influence on the valuation of bonds and the making of investment choices.
Verified Answer
KL
Kylie LeitenbergerJun 22, 2024
Final Answer :
B
Explanation :
The term structure of interest rates, which is depicted by the yield curve, may be downward sloping if the market expects lower inflation in the future, which is reflected in a decreasing inflation premium with maturity. This expectation would lead to lower yields for longer-term bonds compared to short-term bonds.
Learning Objectives
- Examine the configuration of interest rates over time and its influence on the valuation of bonds and the making of investment choices.