10 Questions
The term structure of interest rates is
the relationship among interest rates on bonds with different maturities
According to the liquidity premium theory
all of the above are true
It cannot explain the empirical fact that interest rates on bonds of different maturities tend to move together
segmented markets theory
The default risk premium
brings the expected yield on a security into equality with the expected yield on a default-free security
If the preferred habitat theory is correct, a reduction by the Treasury in the supply of 30-year bonds should
increase their price and lower their yield
Under the preferred habitat theory, a flat yield curve indicates that investors expect future short-term rates to
fall
What is the most important contrast between the segmented markets theory and the expectations theory?
The expectation theory states that investors view similar assets that differ only with respect to maturity as perfect substitutes
According to the liquidity premium theory
a downward sloping yield curve indicates that short-term interest rates are expected to fall sharply in the future
In actual practice, short-term interest rates are just as likely to fall as to rise; this is the major shortcoming of the
expectations theory
Yield curves can be
all of the above
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.
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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