17. If investors feel that half of the time future spot rates will rise and half...

17. If investors feel that half of the time future spot rates will rise and half of the time they will decline, the liquidity preference theory

(a) shows the average yield curve will be flat.

(b) does not explain the declining yield curve situation.

(d) is not valid.

(e) suggests there will be a majority of upward sloping yield curves.

18. The theory that states yield curve slope is formed by the relationship of supply and demand curves for various security maturities is:

(a) liquidity preference theory.

(b) term structure theory.

(d) risk minimization theory

(e) unbiased expectations theory.

Solutions

Expert Solution

17. If investors feel that half of the time future spot rates will rise and half of the time they will decline, the liquidity preference theory, suggests there will be a majority of upward sloping yield curves. The liquidity preference theory states that the investors usually demand a higher rate of interest or a maturity risk premium on securities with long-term maturities which results in a upward sloping yield curve for majority of the time irrespective of the future spot rates.

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18. Market Segmentation Theory states that the yield curve slope is formed by supply and demand curves for various maturities .i,e. debt instruments of different maturities.This resulting difference in the supply and demand in each of the market segment results in the difference in prices of the bonds and thus the yields.

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