If long-term interest rates are 8% and short-term interest rates are 3%, the market expects that:  A)short-term rates will remain the same in the future. B)there is no relationship between long-term and short-term rates. C)short-term rates will rise in the future. D)short-term rates will fall in the future.

Question
Asked Apr 11, 2019
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If long-term interest rates are 8% and short-term interest rates are 3%, the market expects that:

 

 

A)

short-term rates will remain the same in the future.

 

B)

there is no relationship between long-term and short-term rates.

 

C)

short-term rates will rise in the future.

 

D)

short-term rates will fall in the future.

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Expert Answer

Step 1

Short-term interest rates are the interests on short-term financial instruments (assuming other things constant).

Long-term interest rates are the interest rates on long-term financial instruments (assuming other things constant).

Step 2

Short-term interest rates are usually lower than long-term interest rates. It is because long-term financial instruments carry higher risk of returns being worn-off due to inflation overtime and make investors part with their money for a longer period of time. Hence, in order to attract  investors to invest in long-term instruments, they must be offered higher returns.

Step 3

Assuming that all other things are constant, there is no explicit correlation between long-term and short-term interest rates. It is because sh...

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