LOS b: Describe a yield curve and the various shapes of the yield curve.

Q1. A normally sloped yield curve has a:

A)   positive slope.

B)   zero slope.

C)   negative slope.

Q2. Which of the following yield curves represents a situation where long-term rates are less than short-term rates?

A)   Normal yield curve.

B)   Inverted yield curve.

C)   Humped yield curve.

Q3. A downward sloping yield curve generally implies:

A)   shorter-term bonds are less risky than longer-term bonds.

B)   interest rates are expected to decline in the future.

C)   interest rates are expected to increase in the future.

Q4. If investors expect future rates will be higher than current rates, the yield curve should be:

A)   vertical.

B)   downward sweeping.

C)   upward sweeping.

Q5. The concept of spot and forward rates is most closely associated with which of the following explanations of the term structure of interest rates?

A)   Segmented market theory.

B)   Liquidity premium theory.

C)   Expectations hypothesis.

Q6. Which of the following best explains the slope of the yield curve?

A)   The nominal spread between two securities with different maturities.

B)   The credit spread between two securities with different maturities.

C)   The term spread between the yields of two maturities.

Q7. Which of the following is the shape of an inverted yield curve or term structure?

A)   Downward sloping.

B)   Flat.

C)   Upward sloping.

LOS b: Describe a yield curve and the various shapes of the yield curve.fficeffice" />

Q1. A normally sloped yield curve has a:

A)   positive slope.

B)   zero slope.

C)   negative slope.

Correct answer is A)

A normally shaped yield curve is one in which long-term rates are greater than short-term rates, thus the curve exhibits a positive slope.

Q2. Which of the following yield curves represents a situation where long-term rates are less than short-term rates?

A)   Normal yield curve.

B)   Inverted yield curve.

C)   Humped yield curve.

Correct answer is B)

A normal yield curve is one in which long-term rates are greater than short-term rates. A humped yield curve represents a situation where rates in the middle of the maturity spectrum are higher or lower than those for both bonds with a short and long-term maturity.

Q3. A downward sloping yield curve generally implies:

A)   shorter-term bonds are less risky than longer-term bonds.

B)   interest rates are expected to decline in the future.

C)   interest rates are expected to increase in the future.

Correct answer is B)

Since a yield curve has time on the x-axis and rates on the y-axis, when the yield curve is downward sloping it means that rates are expected to decline. 

Q4. If investors expect future rates will be higher than current rates, the yield curve should be:

A)   vertical.

B)   downward sweeping.

C)   upward sweeping.

Correct answer is C)

When interest rates are expected to go up in the future the yield curve will be upward sweeping because time is on the x-axis and rates are on the y-axis, thus forming an upward sweeping curve.

Q5. The concept of spot and forward rates is most closely associated with which of the following explanations of the term structure of interest rates?

A)   Segmented market theory.

B)   Liquidity premium theory.

C)   Expectations hypothesis.

Correct answer is C)

The pure expectations theory purports that forward rates are solely a function of expected future spot rates. In other words, long-term interest rates equal the mean of future expected short-term rates. This implies that an investor could earn the same return by investing in a 1-year bond or by sequentially investing in two 6-month bonds. The implications for the shape of the yield curve under the pure expectations theory are:

§   If the yield-curve is upward sloping, short-term rates are expected to rise.

§   If the curve is downward sloping, short-term rates are expected to fall.

§   A flat yield curve implies that the market expects short-term rates to remain constant.

Q6. Which of the following best explains the slope of the yield curve?

A)   The nominal spread between two securities with different maturities.

B)   The credit spread between two securities with different maturities.

C)   The term spread between the yields of two maturities.

Correct answer is C)

Since the yield curve depicts the yield on securities with different maturities, the slope of the curve between two maturities is a function of the maturity spread.

Q7. Which of the following is the shape of an inverted yield curve or term structure?

A)   Downward sloping.

B)   Flat.

C)   Upward sloping.

Correct answer is A)        

An inverted yield curve reflects the condition where long-term rates are less than short-term rates, giving it a downward (negative) slope.

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