Question #8
Reading: Reading 25 The Term Structure and Interest Rate Dynamics
PDF File: Reading 25 The Term Structure and Interest Rate Dynamics.pdf
Page: 3
Status: Correct
Correct Answer: B
Question
Which theory explains the shape of the yield curve by considering the relative demands for various maturities?
Answer Choices:
A. The pure expectations theory
B. The segmentation theory
C. The liquidity premium theory. Carol Stephens, CFA, oversees five portfolio managers who all manage fixed income portfolios for one institutional client. Stephens feels that interest rates will change over the next year but is uncertain about the extent and direction of this change. She is confident, however, that the yield curve will change in a nonparallel manner and that modified duration will not accurately measure the overall total portfolio's yield-curve risk exposure. To help her evaluate the risk of her client's total portfolio, she has assembled the table of rate durations shown below. Issue Value ($millions) 3 mo 2 yr 5 yr 10 yr 15 yr 20 yr 25 yr 30 yr Portfolio 1 100 0.03 0.14 0.49 1.35 1.71 1.59 1.47 4.62 Portfolio 2 200 0.02 0.13 1.47 0.00 0.00 0.00 0.00 0.00 Portfolio 3 150 0.03 0.14 0.51 1.40 1.78 1.64 2.34 2.83
Explanation
The market segmentation theory contends that lenders and borrowers have preferred
maturity ranges, and that supply and demand forces in each maturity range determines
yields. This theory relies on the idea that some investors have restrictions (either legal or
practical) on their preferred maturity structure and that they are unwilling or unable to
move out of their preferred ranges.
(Module 25.5, LOS 25.h)
Carol Stephens, CFA, oversees five portfolio managers who all manage fixed income portfolios for one
institutional client. Stephens feels that interest rates will change over the next year but is uncertain about the
extent and direction of this change. She is confident, however, that the yield curve will change in a nonparallel
manner and that modified duration will not accurately measure the overall total portfolio's yield-curve risk
exposure. To help her evaluate the risk of her client's total portfolio, she has assembled the table of rate
durations shown below.
Issue
Value
($millions)
3 mo
2 yr
5 yr
10 yr
15 yr
20 yr
25 yr
30 yr
Portfolio 1
100
0.03
0.14
0.49
1.35
1.71
1.59
1.47
4.62
Portfolio 2
200
0.02
0.13
1.47
0.00
0.00
0.00
0.00
0.00
Portfolio 3
150
0.03
0.14
0.51
1.40
1.78
1.64
2.34
2.83
Portfolio 4
250
0.06
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Portfolio 5
300
0.00
0.88
0.00
0.00
1.83
0.00
0.00
0.00
The value of the total portfolio is $1,000,000,000.