Which statement is an interpretation of an upward-sloping yield curve?

A. Government bonds tend to pay off in bad economic times.
B. Bond market participants expect short-term interest rates to decline.
C. Short-dated bonds are less positively (or more negatively) correlated with bad times than are long-dated bonds.

Correct Answer: C

Short-dated bonds have been more reliable hedges against bad economic times than long-dated bonds. This means the bond risk premium should be higher for long-dated government bonds than for their short-dated equivalents. The yield curve should be upward-sloping to reflect this result.

Statement B can explain the downward sloping UK gilt curve in the summer of 2007.