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I'm working on this supposed to be a simple multiple choice question: The yield curve indicates?

A. the relationship between existing short, medium and longer term interest rates, independent of expectations about future interest rates.

B. the relationship between the existing cash rate and the expected level of cash rate in the future

C. expectations about future levels of medium and longer term interest rates

D. among other things, expectations about the future levels of the cash rate and hence about future monetary policy

I believe all the answer could be correct, but I'm leaning toward A because the yield curve could be seen as a "snapshot" of short, med and long term rates. Hence, although the expectation of future cash rate or monetary policy does affect short and long term rate, the existing yield curve should already capture these expectations. But A could be wrong because of the word "independent" alone.

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D)

A can be eliminated because the yield curve includes expectations of future rates (forward rates).

B is true but incomplete because it doesn't include monetary policy or current long term rates.

C is mostly true, but incomplete because it doesn't mention the expectations for future short term rates. You could also make an argument that the curve does not include expectations for long term rates. For example, if the curve goes out to 30 years, it does not give you the 6 month forward 30 year rate. Therefore if your definition of "long term rates" is the 30 year rate, the curve does not provide expectations for

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  • $\begingroup$ So you are saying A B C are mostly correct but are incomplete, hence the word "among other things" in D correct this problem? $\endgroup$ – Sirus Aug 18 '18 at 21:55
  • $\begingroup$ On A, the yield curve may be influenced by expectations of future rates but the empirical evidence suggests that it also includes an unmeasurable but probably variable term premium so that the current short term interests rates combined with future short term interest rates are usually lower than current long term interest rates $\endgroup$ – Henry Aug 18 '18 at 23:20
  • $\begingroup$ Yes, I suggested D largely for the "among other things". $\endgroup$ – Charles Fox Aug 19 '18 at 1:57

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