In the expectations plus term premium framework for long-term bond yields, what components comprise the yield?

In the expectations plus term premium framework for long-term bond yields, what components comprise the yield?

• A. The bond's coupon rate plus a default risk premium.
• B. The current yield to maturity.
• C. The expected average path of future short-term rates plus a term premium reflecting extra yield for bearing long maturities (and, in some models, a separate risk premium).
• D. Inflation expectations only.

Answer: (C)

In this framework, the yield on a long-term bond is explained as the expected average path of future short-term rates over the life of the bond, plus a term premium that compensates for the extra risk of holding a longer maturity. Some models also include a separate risk premium for additional uncertainty or credit risk. So, if investors expect short-term rates to average 2% over the bond’s term and there’s a 0.5% term premium, the long-run yield would reflect about 2.5% (plus any risk premium). The coupon affects cash flows, but the yield is determined by expected future rate movements and the premia, not by the coupon alone. This view is not just the current yield to maturity, nor is it inflation expectations only or a default premium; those elements are either embedded in the expected rate path and premia or pertain to different contexts.

In this framework, the yield on a long-term bond is explained as the expected average path of future short-term rates over the life of the bond, plus a term premium that compensates for the extra risk of holding a longer maturity. Some models also include a separate risk premium for additional uncertainty or credit risk. So, if investors expect short-term rates to average 2% over the bond’s term and there’s a 0.5% term premium, the long-run yield would reflect about 2.5% (plus any risk premium). The coupon affects cash flows, but the yield is determined by expected future rate movements and the premia, not by the coupon alone. This view is not just the current yield to maturity, nor is it inflation expectations only or a default premium; those elements are either embedded in the expected rate path and premia or pertain to different contexts.