An investor invests in high-quality bonds. If the yield curve starts to slope do

Question

An investor invests in high-quality bonds. If the yield curve starts to slope downward,

an expansion is predicted and a bond investor should buy bonds with long maturities

an expansion is predicted and a bond investor should buy bonds with short maturities

a recession is predicted and a bond investor should buy bonds with short maturities

a recession is predicted and a bond investor should buy bonds with long maturities

an expansion is predicted and a bond investor should buy bonds with long maturities

an expansion is predicted and a bond investor should buy bonds with short maturities

a recession is predicted and a bond investor should buy bonds with short maturities

a recession is predicted and a bond investor should buy bonds with long maturities

Explanation / Answer

Solution.

If the yield curve starts to slope downward, a recession is predicted and a bond investor should buy bonds with long maturities

A flat yield curve can develop into the dreaded "inverted" yield curve when the economic outlook is very bleak. When the yield curve inverts, The logic goes like this: If I'm worried the economy is going to crash, I want to look for safe ways of preserving my capital. If I suspect falling equity prices, and falling interest rates, I'm going to try to lock my capital away in longer-term bonds as a way to ride out the storm. As more and more investors do this, it drives longer maturity bond prices up, and the yields down. These same investors will shy away from short-term bonds, which may have to be reinvested during the downturn. This lack of demand drives short-term treasury prices down and the yields up

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