Chapter 7 Fixed-Income securities pricing and trading

Question 1

What are the three theories of yield curve?

Answer 1

1. Market segmentation theory
2. Liquidity preference theory
3. Expectations theory

Question 2

Explain the market segmentation theory.

Answer 2

The market segmentation theory explains that different financial institutions buy different termed bonds. creating a supply and demand for different terms. Chartered banks generally buy short-term bonds while Insurance companies buy longer term bonds.

Question 3

Explain the liquidity preference theory.

Answer 3

The liquidity preference theory explains that investors prefer short term bonds because they are more liquid and less volatile in price. If an investor were to be interested in buying a longer term bond they would need greater compensation for illiquidity and price volatility.

Question 4

Explain the expectations theory.

Answer 4

The expectations theory says that a long term bond should equal the interest of two short term bonds.

Question 5

What is the sell side of the fixed-income securities market?

Answer 5

The sell side is where investment dealers buy and sell fixed-income securities and create new issues. They also act as agents. Inter-broker dealers wholesale buy and sell securities acting as market maker.

Investment banker
Trader
Sales representative

Question 6

What is the buy side of the fixed-income securities market?

Answer 6

The buy side deals with asset management. Buying fixed-income securities for clients. They buy and sell securities and do research/commentary.

Trader
Portfolio manager