25: Term Structure & Interest Rate Dynamics

Question 1

In the segmented markets theory, the shape of the yield curve is influenced by:

Answer 1

market participants preferences for particular maturities

Question 2

Asserts that liquidity premiums exist to compensate investors for the added interest rate risk they face when lending long term and that these premiums increase with maturity

Answer 2

Liquidity preference theory

Question 3

Pure expectations theory asserts that no matter what bond you buy, all would return the same amount over some given holding period,
therefore Forward rates are:

Answer 3

Forward rates are unbiased predictors of future spot rates

This does not hold in real world

Question 4

Local Expectations theory suggests that over a short holdings period (3-6 months), all bonds return:

Answer 4

the same risk-free rate (3-6 month spot rate)

Question 5

Segmented market theory assumes that participants are unwilling/unable to invest in anything other than:

Answer 5

securities of their preferred maturity