1215

Which of the following statements regarding the different theories of the term structure of interest rates is least accurate?

A) The preferred habitat theory suggests that investors prefer to stay within a particular maturity range of the yield curve regardless of yields in other maturity ranges.

B) The market segmentation theory, pure expectations theory, preferred habitat theory, and liquidity preference theory are all consistent with any shape of the yield curve.

C) An upward sloping yield curve can be consistent with the liquidity preference theory even with expectations of declining short term interest rates.

---

The preferred habitat theory states that investors prefer to stay within a particular maturity range but will move from their preferred range to another area on the curve to achieve higher yields. With the liquidity preference theory the yield curve can remain upward sloping even if short term rates are predicted to decline as long as the liquidity premium is sufficiently large.

1215

Which of the following is a correct interpretation of forward rates under the pure expectations hypothesis? Forward rates are equal to the expected future:

A) spot rates.

B) rate differences between short and long-term bonds.

C) risk premiums on short-term bills.

---

The pure expectations theory purports that forward rates are solely a function of expected future spot rates.