Which yield curve theory is based on the premises that financial instruments of different terms are not substitutable and therefore the supply and demand in the markets for short-term and long-term instruments is determined largely independently?
Question 1 options
The expectation hypothesis.
All of these answers.
The segmented market hypothesis.
The liquidity premium theory.
Which yield curve theory is based on the premises that financial instruments of different terms are not substitutable and therefore the supply and demand in the markets for short-term and long-term instruments is determined largely independently?
Question 1 options
The expectation hypothesis. | |
All of these answers. | |
The segmented market hypothesis. | |
The liquidity premium theory. |
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Nominal Interest Rates and Yield Curves: A recent study of inflationary expectations has revealed that the concensus among economic forecasters yields the following average annual rates of inflation expected over the periods noted. (Note: Assume that the risk that future interetst rate movements will affect the longer maturities more than the shorter maturities is 0; that is, assume that there is no maturity risk)
Period | Avg Annual Rate of Inflation |
3 Months | 5% |
2 Years | 6% |
5 Years | 8% |
10 Years | 8.5% |
20 Years | 9% |
A) If the real rate of interest is currently 2.5%, find the nominal rate of interest on each of the following U.S. Treasury issues: 20-year bond, 3-month bill, 2-year note, and 5 year bond
B) If the real rate of interest suddenly dropped to 2% without any change in inflationary expectations, what effect, if any, would it have on your answers in part a? Explain
C) Using your findings in part a, draw a yield curve for U.S. Treasury securities.
D) What would a follower of the liquidity preference theory say about the preferences of lenders and borrowers tend to affect the shape of the yield curve drawn in part C? Illustrate that effect by placing on your graph a dotted line that approximates the yield curve without the effect of liquidity preference
E) What would a follower of the market segmentation theory say about the supply and demand for long term loans versus the supply and demand for short term loans given the yield curve constructed for part C of this problem?
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