Interest Rate Options (2)

Question 1

What is a yield curve?

Answer 1

The longer the term of an asset to maturity, the higher rate of interest paid on the asset

Question 2

What does expectations theory represent?

Answer 2

The curve may reflect expectations that interest rates will rise in the future

Question 3

What does liquidity preference theory represent?

Answer 3

The curve reflects the compensation that investors require higher returns for sacrificing liquidity on long-dated bonds

Question 4

What does market segmentation theory represenmt?

Answer 4

Short-dated bonds tend to be more popular with banks, and long-dated bonds are more popular with pensions funds

Question 5

WHat does marget segmentation theory suggest?

Answer 5

Slope of the yield curve will reflect conditions in different segments of the market

Question 6

How is the yield curve influenced?

Answer 6

By market’s expectations of future interest rate movements

Question 7

What happens when the yield cirve starts sloping steeply upwards?

Answer 7

A rise in interest rates in the future, therefore a company is more concerned about managing interest rate risk