Which of the following is true? Explain why. 1. Suppose financial institutions w

Question

Which of the following is true? Explain why.

1. Suppose financial institutions were required by law to make long term, fixed income rate mortgages, but at the same time, they were largely restricted, in terms of their capital sources, to taking deposits that could be withdrawn on demand. Under these circumstances, these financial institutions would prefer a normal yield curve to in inverted curve.

2. The yield curve is upward sloping, or normal, if short term rates are higher than long term rates.

Explanation / Answer

The first statement is correct.

The regulator would prefer a normal yield curve which indicates that the market participants are willing to take long term risk. Inverted curve implies that investors are not willing to invest in long term, which is seen as a sign of recession.

The second statement is correct because in upward sloping curve, short term rates are lower than long term rates.

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