Suppose that the current yield for a 20-year Treasury bond falls below the curre

Question

Suppose that the current yield for a 20-year Treasury bond falls below the current one-year bond yield. Which of the following is true regarding the segmented markets theory of the term structure of interest rates in this case? A.  The 20-year bond yield falls below the one-year bond yield because the interest rate on the one-year bond is expected to fall in this case. B.  The one-year bond yield lies above the 20-year bond yield because investors prefer long-term bonds in this case. C.  The 20-year bond yield falls below the one-year bond yield because people prefer shorter-term bonds in this case. D.  The 20-year bond yield exceeds the one-year bond yield because investors require a liquidity premium for bonds with a longer term to maturity in this case. Suppose that the current yield for a 20-year Treasury bond falls below the current one-year bond yield. Which of the following is true regarding the segmented markets theory of the term structure of interest rates in this case? A.  The 20-year bond yield falls below the one-year bond yield because the interest rate on the one-year bond is expected to fall in this case. B.  The one-year bond yield lies above the 20-year bond yield because investors prefer long-term bonds in this case. C.  The 20-year bond yield falls below the one-year bond yield because people prefer shorter-term bonds in this case. D.  The 20-year bond yield exceeds the one-year bond yield because investors require a liquidity premium for bonds with a longer term to maturity in this case.

Explanation / Answer

Option B) is the correct answer .

If current one year bond yield is high, then in the future the yields are expected to decline. This increases the demand for long-term bonds by investors who want to lock in high rates while decreasing the supply. Hnece, the current yield on the 20 year bond is lower than the one year bond.

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