Chartered Financial Analyst (CFA) Practice Exam Level 2

What is a key factor contributing to yield volatility in the long term?

1. Monetary policy uncertainty

2. Fluctuations in bond pricing

3. Real economic growth and inflation uncertainty

4. Changes in corporate earnings

The correct answer is: Real economic growth and inflation uncertainty

Long-term yield volatility is significantly influenced by uncertainty regarding real economic growth and inflation. This relationship arises because investors seek to adjust their expectations for future interest rates based on their perceptions of the economy's health and the potential for inflation to erode purchasing power. When there is uncertainty about real economic growth, it affects the expected returns on investments and the risk premium. If investors doubt the economy's stability, they might demand a higher yield on bonds to compensate for the perceived risk, contributing to yield volatility. Additionally, inflation impacts the purchasing power of future cash flows from bonds. Higher-than-expected inflation can lead to higher interest rates, which typically cause bond prices to fall, further influencing yield volatility. Conversely, aspects like monetary policy uncertainty or fluctuations in bond pricing do play roles but are often more immediate in their effects, while real economic growth and inflation uncertainty represents a broader and often more prolonged factor influencing investor sentiment and bond market dynamics. Changes in corporate earnings primarily affect equity markets rather than the bond yield directly, though they can influence economic perceptions indirectly.