The expectations theory of the term structure of interest rates

1. Discuss the expectations theory of the term structure of interest rates.
   A. Discuss why the interest rate on a long-term bond will equal the average of short-term
   interest rates that people expect in the future.
   B. Discuss some problems with this theory.
2. Discuss the liquidity premium theory of the term structure of interest rates.
   A. Discuss how this theory changes the slope of the yield curve when compared to the
   one found using the expectations theory.
   B. Why does this theory appear more consistent with the data when compared to the
   expectations theory?
3. Discuss how you might interpret an upward sloping yield curve. Flat yield curve. Downward
   sloping yield curve. (EACH THEORY)
4. Find the current yield curve for U.S. Treasuries or any other country and explain what you
   think this implies for future economic activity (PROVIDE ACTUAL YIELD CURVE IN
   PAPER). Expansion or Recession? Status Quo?

Sample Solution