Chartered Financial Analyst (CFA) Practice Exam Level 2

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What is the main factor impacting short-term yield volatility?

  1. Interest in long-term economic policies

  2. Inflation expectations

  3. Uncertainty from monetary policy

  4. Investor sentiment

The correct answer is: Uncertainty from monetary policy

The primary factor impacting short-term yield volatility is uncertainty from monetary policy. Short-term yields are highly sensitive to changes and perceptions regarding monetary policy because they are closely tied to the central bank's interest rate decisions. When there is uncertainty about future monetary policy, such as potential changes in interest rates or shifts in quantitative easing measures, market participants may adjust their expectations rapidly. This can lead to increased fluctuations in short-term yields, as investors react to new data or statements from policymakers. For instance, if economic data suggests inflation is rising, investors might expect the central bank to raise interest rates sooner than anticipated, resulting in a spike in short-term yields. Conversely, if there's a hint that the central bank may pause rate hikes or lower rates, yields may decrease as investors reassess the outlook. This dynamic illustrates how monetary policy uncertainty can lead to significant volatility in short-term bond yields, making it the main driver in this context. Other factors like inflation expectations, long-term economic policies, and investor sentiment can affect yield levels and trends, but they typically do not influence short-term yield volatility as directly or significantly as uncertainty surrounding monetary policy.