Question

Explain and describe the shape of the yield curve if investors think that short-term interest rates are likely to decrease in the future. Why does the yield curve have this shape?

Answer 1

The shape of yield curve would be downward sloping as the investors are expecting the the future short term rates to go down.

The yield curve is a representation of an expectation of the future short term bond yields so if the future short term bond yields are going to go up, it is a sign of upward sloping Yield curve and if the short term interest rates are going to decrease in the future, then it is a sign of downward sloping yield curve.

Yield curve will have the downward slope because people are expecting that there would not be growth in the economy so it would be represented through lower rate of return in the form of bond yields.