Question #41
Reading: Reading 25 The Term Structure and Interest Rate Dynamics
PDF File: Reading 25 The Term Structure and Interest Rate Dynamics.pdf
Page: 16
Status: Incorrect
Correct Answer: B
Your Answer: C
Question
During the recent credit crises in the country of Maltovia, several money market funds reported large losses. Subsequently, the Maltovian regulatory body imposed strict restrictions on maturity of securities that money market funds could invest in. The reaction of Maltovian regulatory body was most likely based on a belief in:
Answer Choices:
A. market segmentation theory
B. preferred habitat theory
C. local expectations theory
Explanation
Money market funds generally invest in short-term securities. Their inclination to chase
higher yields in the longer maturity spectrum is consistent with the preferred habitat
theory whereby investors will leave their preferred habitat if they are compensated with
higher returns. If Market segmentation theory held, investors would not have left their
market segment and therefore no regulatory action would be necessary.