In the foreseeable future, the real risk-free rate of interest, r*, is expected to remain at 3%, inflation is expected to steadily increase, and the maturity risk premium is expected to be 0.1(t 1)%, where t is the number of years until the bond matures. given this information, which of the following statements is correct? a. the yield curve must be "humped." b. the yield on 2-year treasury securities must exceed the yield on 5-year treasury securities. c. the yield on 5-year corporate bonds must exceed the yield on 8-year treasury bonds. d. the yield curve must be upward sloping. e. the yield on 5-year treasury securities must exceed the yield on 10-year corporate bonds.

Option (d) is correct.

Explanation:

Given that,

Real risk-free rate of interest, r* = 3%

Inflation is expected to increase and the maturity risk premium is expected to be 0.1(t - 1)%.

where,

t is the number of years until the bond matures

It is given that expected inflation increases and maturity risk premium also increases with increase in the number of years. Hence, the yield curve is upward sloping.

The slope of the yield curve tells us about the direction of the short term interest rate in the near future. If the curve is downward sloping then this would indicates that all the financial markets expects a lower interest rate in the near future.

On the other hand, if the curve is upward sloping then this would indicates that all the financial markets expects a higher interest rate in the near future because central bank come out with a contractionary monetary policy. This means that central bank have to increase interest rate to decrease the money supply in an economy.

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