In this question, we are asked to identify the correct statement among the options provided regarding the yield curve and related concepts:
- Statement A: If the yield curve is upward sloping, the maturity risk premium must be positive and the inflation rate must be zero.
- Statement B: The actual shape of the yield curve depends only on expectations about future inflation.
- Statement C: If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future.
- Statement D: Yield curves must be either upward or downward sloping they cannot first rise and then decline.
- Statement E: Downward sloping yield curves are inconsistent with the expectations theory.
Let's analyze each statement:
A. If the yield curve is upward sloping, it means longer-term interest rates are higher than short-term rates. This does not imply the inflation rate is zero. Therefore, this statement is incorrect.
B. The shape of the yield curve is influenced by expectations of future interest rates, not solely by expectations about future inflation. This statement oversimplifies the factors affecting the yield curve, so it is incorrect.
C. The pure expectations theory suggests that a downward sloping yield curve indicates that interest rates are expected to decrease in the future. This statement aligns with the theory, so it is correct.
D. Yield curves can exhibit various shapes, including initially rising and then declining. This statement is incorrect as yield curves are not limited to just upward or downward sloping shapes.
E. Downward sloping yield curves are consistent with the expectations theory. This statement is incorrect as downward sloping yield curves can be explained by the expectations theory.
Therefore, the correct statement among the options provided is:
C. If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future.
