Question #50

Reading: Reading 25 The Term Structure and Interest Rate Dynamics

PDF File: Reading 25 The Term Structure and Interest Rate Dynamics.pdf

Page: 21

Status: Unattempted

Correct Answer: B

Part of Context Group: Q50-51 First in Group
Shared Context
- The comment made by Ross is most likely: A) inaccurate with respect to the statement about spot rates, forward rates, and yields. B) inaccurate with respect to the statement about rolling down the yield curve. C) inaccurate in both respects.
Question
Smith's comments about interest rates in Happyland most likely supports which theory of the term structure of interest rates?
Answer Choices:
A. Liquidity preference theory
B. Segmented markets theory
C. Local expectations theory
Explanation
The segmented markets theory states that the shape of the yield curve is determined by varying levels of supply and demand for bonds of specific maturities, and investors only deal in bonds with their preferred maturities, regardless of yields on bonds of different maturity. The preferred habitat theory has similar principles, but investors may be tempted to invest in bonds that are not of their preferred maturity if expected returns are attractive enough, with low prices and high yields.
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