Question

If the YTM on a 20 year T-bond is lower than the YTM on a 3 month T-bill, then, according to the expectations hypothesis theory,

A. Investors expect future short rates to be higher than the current 3 month interest rate.
B. Investors expect future short rates to be equal to the current 3 month interest rate.
C. Investors expect future short rates to be lower than the current 3 month interest rate.

Answer 1

The correct option is C,investors expect future short rates to be lower than the current 3 month interest rate.

Step-by-step explanation:

The yield to maturity is the effective interest rate on a debt obligation which implies the actual return that investors receive by investing in bonds.

The yield to maturity is different from the coupon interest which is the actual amount of cash receivable by investors periodically.

Specifically,a higher yield on short term T-bill means that investors expect that the future interest rates on long-term dated bonds to be much lower.

This is due to the fact the longer the time to maturity the more uncertain the interest rates in the bond markets become.