Barbow enterprises, inc | Business & Finance homework help
According to the pure expectations theory, investors’ decisions in regards to their financial investments are based on their anticipated returns over a certain time period. This concept implies that changes in expected future rates of return will affect the current yield curve as well—meaning long-term bonds tend to have higher yields than short-term bonds due to the greater risk associated with them (i.e., potential for rising inflation).
In other words, if investors expect interest rates to increase in future then they will demand higher yields from long-term bonds today—and thus the yield curve would shift upwards. On the other hand, if investors anticipate lower interest rates down the line then this would lead them to prefer shorter maturities which currently offer lower yields—thus causing the yield curve to flatten out or even become inverted (i.e., where short-term bond yields are higher than those of longer-term ones).
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