Question

If bond investors decide that $30$-year bonds are no longer as desirable an investment as they were previously, predict what will happen to the yield curve, assuming (a) the expectations theory of the term structure holds, and (b) the segmented markets theory of the term structure holds.

Short answer

The expectations theory of the term structure holds the yield curve would slope even higher upward, a decrease in demand for $30$-year bonds would not affect the curve.

Step-by-step solution

Definition

Expectations theory says that outcomes do not differ regularly or are predictable from what people expected them to be. It entails that the interest rate on a long-term bond will be equal to the average of the expected short-term interest rates over the life of the long-term bond

Explanation

Assume that investors determine that $30$-year(long-term)bonds aren't as appealing as they once were. This would cause the price of $30$-year bond to decrease due to a decrease in their demand, and their interest rate to increase. It assumes that there are no effects from expected returns on other bonds with other maturities. The segmented markets hypothesis, unlike the expectation theory, considers bond markets with various maturities to be independent markets. Since the yield curve depicts the yields on bonds with different maturities but same risk, liquidity, and tax considerations, a decrease in demand for $30$-year bonds are separate from ones with differing maturities.