Understanding the Term Structure of Interest Rates
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Questions and Answers

The term structure of interest rates is

  • the relationship among interest rates of different bonds with the same maturity.
  • the structure of how interest rates move over time.
  • the relationship among the terms to maturity of different bonds.
  • the relationship among interest rates on bonds with different maturities (correct)
  • According to the liquidity premium theory

  • a steeply rising yield curve indicates that short-term interest rates are expected to rise in the future
  • a moderately rising yield curve indicates that short-term interest rates are not expected to change much in the future
  • a flat yield curve indicates that short-term interest rates are expected to fall moderately in the future
  • all of the above are true (correct)
  • It cannot explain the empirical fact that interest rates on bonds of different maturities tend to move together

  • segmented markets theory (correct)
  • expectations theory
  • liquidity premium theory
  • both (a) and (b) of the above
  • The default risk premium

    <p>brings the expected yield on a security into equality with the expected yield on a default-free security</p> Signup and view all the answers

    If the preferred habitat theory is correct, a reduction by the Treasury in the supply of 30-year bonds should

    <p>increase their price and lower their yield</p> Signup and view all the answers

    Under the preferred habitat theory, a flat yield curve indicates that investors expect future short-term rates to

    <p>fall</p> Signup and view all the answers

    What is the most important contrast between the segmented markets theory and the expectations theory?

    <p>The expectation theory states that investors view similar assets that differ only with respect to maturity as perfect substitutes</p> Signup and view all the answers

    According to the liquidity premium theory

    <p>a downward sloping yield curve indicates that short-term interest rates are expected to fall sharply in the future</p> Signup and view all the answers

    In actual practice, short-term interest rates are just as likely to fall as to rise; this is the major shortcoming of the

    <p>expectations theory</p> Signup and view all the answers

    Yield curves can be

    <p>all of the above</p> Signup and view all the answers

    Study Notes

    Theories of Interest Rate Structure

    • The liquidity premium theory fails to explain the empirical fact that interest rates on bonds of different maturities tend to move together.

    Preferred Habitat Theory

    • A reduction in the supply of 30-year bonds by the Treasury should lead to an increase in their price and a decrease in their yield, according to the preferred habitat theory.
    • A flat yield curve indicates that investors expect future short-term rates to be low.

    Segmented Markets Theory vs. Expectations Theory

    • The most important contrast between the segmented markets theory and the expectations theory is their approach to explaining the term structure of interest rates.

    Liquidity Premium Theory

    • The major shortcoming of the liquidity premium theory is that it assumes short-term interest rates are more likely to rise than fall, which is not the case in actual practice.

    Yield Curves

    • Yield curves can be influenced by various factors, including the supply and demand of bonds with different maturities.

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    Description

    This quiz will test your knowledge on the term structure of interest rates, including concepts such as yield curves, short-term vs long-term interest rates, and their impact on the economy.

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