When the spot curve is upward sloping, the forward curve will generally:[Fill in the blank]

Question

BlackTom AI · Accepted Answer

When the spot curve is upward sloping, it means longer-term rates are higher than shorter-term rates, reflecting expectations of higher future interest rates or additional term premium.
Option a: Be flat. If the spot curve is upward sloping, the forward curve is generally not flat, because forward rates incorporate the changing expectations embedded in the term structure. This choice ignores the typical upward shift in forward rates that accompanies an upward-sloping spot curve.
Option b: Be equal to the par curve. The par curve is a theoretical construct of coupon payments that would price a coupon bond at par for each maturity. Forward rates are not constrained to equal the par curve; they reflect the market's expected future rates and term premium, which typically diverge from the par curve when the spot curve is upward sloping.
Option c: Lie below the spot curve. For an upward-sloping spot curve, short maturities imply lower rates than longer maturities. The forward curve, which prices future periods based on today’s expectations, tends to be above the current short rates and often tracks or sits at or above the spot curve for longer horizons. Saying it lies below the spot curve misrepresents the typical relationship between spot and forward rates in a rising term structure.
Option d: Lie above the spot curve. In an upward-sloping environment, forward rates for future periods must compensate for higher expected future rates and term premium. As a result, the forward curve generally sits above the current spot curve for longer maturities, reflecting these higher anticipated rates.
In summary, the forward curve incorporates expected increases in rates over time, which leads to forward rates being higher than the current spot rates when the spot curve is upward sloping. The other options fail to capture this fundamental relationship between the shapes of the spot and forward curves.

When the spot curve is upward sloping, the forward curve will generally:[Fill in the blank]

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