Question

question 6 (4 points)
listen
which of the following statements is correct?
the higher the maturity risk premium, the higher the probability that the yield curve will be inverted.
the most likely explanation for an inverted yield curve is that investors expect inflation to increase.
the most likely explanation for an inverted yield curve is that investors expect inflation to decrease.
if the yield curve is inverted, short - term bonds have lower yields than long - term bonds.
inverted yield curves can exist for treasury bonds, but because of default premiums, the corporate yield curve can never be inverted.

Explanation:

• Option 1: A higher maturity risk premium would make long - term rates higher, reducing the probability of an inverted yield curve (where short - term rates are higher than long - term rates). So this option is incorrect.
• Option 2: If investors expect inflation to increase, they would demand higher long - term yields (as inflation erodes the value of future cash flows), which would make the yield curve upward - sloping (not inverted). So this option is incorrect.
• Option 3: If investors expect inflation to decrease, they may be willing to accept lower long - term yields. In an inverted yield curve, short - term rates are higher than long - term rates. Lower expected inflation can contribute to lower long - term rates, making this a correct statement.
• Option 4: In an inverted yield curve, short - term bonds have higher yields than long - term bonds. So this option is incorrect.
• Option 5: Corporate yield curves can also be inverted. Default premiums are just an additional component (on top of the risk - free rate, inflation premium, etc.) and do not prevent the corporate yield curve from being inverted. So this option is incorrect.

Answer:

The most likely explanation for an inverted yield curve is that investors expect inflation to decrease.