Compared to long-term government bonds, interest rates on three-month Treasury bills fluctuate ________ and are ________ on average.

Question

BlackTom AI · Accepted Answer

The correct answer is d. more; lower.

Relevant knowledge points and concepts:
- Term structure of interest rates: long-term yields reflect the market’s expectations of future short-term rates plus a term (or liquidity) premium. 
- Monetary policy and money-market shocks primarily move short-term rates; long-term rates are an average of expected future short rates plus a premium. 
- Statistical averaging: averaging several random variables reduces variance.

Step-by-step reasoning:
1. Represent an N-period long-term yield roughly as the average of expected future short-term rates plus a term premium: r_long ≈ (1/N)·(E[r_short1] + E[r_short2] + ... + E[r_shortN]) + term_premium.
2. Volatility argument: if short rates r_short_t are volatile, the variance of the average of N expected future short rates is about Var(r_short)/N (for independent or weakly correlated shocks). Thus Var(r_long) ≈ Var(r_short)/N, which is smaller than Var(r_short). Therefore short-term rates fluctuate more than long-term rates.
3. Level (average) argument: empirical evidence and the liquidity (term) premium imply term_premium > 0 on average, so long-term yields tend to lie above the average of short rates. Therefore three-month T-bill rates are typically lower on average than long-term government bond yields.

Why the correct answer is correct:
- “More” captures the greater volatility of three-month T-bills due to their sensitivity to immediate monetary and liquidity conditions.
- “Lower” reflects that long-term yields include a positive term premium (and typically average expected future short rates), so three-month rates are lower on average.

Why the other options are incorrect:
- (a) more; higher — wrong because although short rates are more volatile, they are not higher on average.
- (b) less; higher — wrong on both counts: short rates are not less volatile and not higher on average.
- (c) less; lower — wrong because short rates are not less volatile than long-term rates.

Conclusion: therefore the best choice is d. more; lower.

Compared to long-term government bonds, interest rates on three-month Treasury bills fluctuate and are on average.Single choice

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Compared to long-term government bonds, interest rates on three-month Treasury bills fluctuate ________ and are ________ on average.Single choice