Question

In: Accounting

Name the two hypotheses that are meant to explain the shape of the yield curve. a)...

Name the two hypotheses that are meant to explain the shape of the yield curve.

a) Liquidity Preference and the Efficient Market Hypothesis
b) Yield Compression and Present Value Bias
c) Present Value Bias and Expected Returns
d) Liquidity Preference and Unbiased Expectations

Solutions

Expert Solution

Answer: Option d) Liquidity preference and Unbiased Expectations

Explanation:

The liquidity theory holds that investors demand a premium to compensate them for interest rate exposure and the premium increases maturity. This theory shows the upward sloping Yield curve. According to the Theory of Liquidity preferense, the short-term interest rate in economy is determined by the law of supply and demand. It gives the clear yield curves for the increase in the rate of interest and premium through increase in maturity.

Unbiased expectation theory is also known as the pure expectations theory, that forward rates for the future is expected soley a function of expected future spot rates. In this theory based on current long-term interest rates contain an implict prediction from short-term interest rates. The two one-year bond would have a lower intrest rate when compared with the two-year bond.

Therefore, liquidity theory and Unbiased expectation theory best explain the  shape of the yield curve

Thus, Option d) is correct and remaining options are incorrect.


Related Solutions

1A-) Using the graph, explain what is meant by the Yield Curve and the forms it...
1A-) Using the graph, explain what is meant by the Yield Curve and the forms it takes? 2A-) By checking at it, do you think that this curve can be used as a future indicator for the performance of the economy?
Question: Explain what is meant by the yield curve and briefly outline three theories to explain...
Question: Explain what is meant by the yield curve and briefly outline three theories to explain unequal yields at different maturities and how it is most often sloped. Then briefly explain why Australia’s yield curve “inverted” during the boom years of 2006-2007.
What is the shape of the current Yield Curve as of July 2020?
What is the shape of the current Yield Curve as of July 2020?
The three basic theories of the yield curve shape are still theories. What indicates that they...
The three basic theories of the yield curve shape are still theories. What indicates that they are still theories?
Name two hypotheses that attempt to explain the biological function of sleep, and give research evidence...
Name two hypotheses that attempt to explain the biological function of sleep, and give research evidence for each.
Does the shape of the yield curve determine how you, as an investor, make investment decisions?...
Does the shape of the yield curve determine how you, as an investor, make investment decisions? If so, in what ways?
Explain the impact of the steepening of the yield curve on two bonds portfolios. Both portfolios...
Explain the impact of the steepening of the yield curve on two bonds portfolios. Both portfolios have equal Macaulay’s duration. The first portfolio is designed as a bullet (100% allocation to the mid-maturity in the yield curve) and the other as a barbell (allocation split between the short and the long maturities in the yield curve). You must demonstrate your answer with an example. 1. Explain the bullet and barbell strategy and why investor are indifferent between choosing one or...
Explain the impact of the steepening of the yield curve on two bonds portfolios. Both portfolios...
Explain the impact of the steepening of the yield curve on two bonds portfolios. Both portfolios have equal Macaulay’s duration. The first portfolio is designed as a bullet (100% allocation to the mid-maturity in the yield curve) and the other as a barbell (allocation split between the short and the long maturities in the yield curve). You must demonstrate your answer with an example. Explain the bullet and barbell strategy and why investor are indifferent between choosing one or the...
illsutrate and explain the shape of the AD curve and thr Sars curve with appropriate diagrams.
illsutrate and explain the shape of the AD curve and thr Sars curve with appropriate diagrams.
Discuss the yield curve and explain how it applies to the yield to maturity (YTM) of...
Discuss the yield curve and explain how it applies to the yield to maturity (YTM) of short and long-term bonds. Explain what causes an inverted yield curve and the impact that it has on bonds prices. Explain how investors can lose money investing in U.S. Treasury Bonds. Please be detailed, Thank you
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT