The pure expectations theory: A. suggests that more liquid securities will trade at higher yields than less liquid securities B. states that an inverse yield curve reflects the market’s expectation that rates will fall in the future C. explains that yield curves will be normal to compensate investors for price risk D. implies that investors prefer securities with longer terms because there are less transaction costs
Question
The pure expectations theory: A. suggests that more liquid securities will trade at higher yields than less liquid securities B. states that an inverse yield curve reflects the market’s expectation that rates will fall in the future C. explains that yield curves will be normal to compensate investors for price risk D. implies that investors prefer securities with longer terms because there are less transaction costs
Solution
The Pure Expectations Theory, also known as the Unbiased Expectations Theory, primarily states that the future short-term interest rates can be estimated based on the current long-term interest rates. This theory assumes that the maturity does not impact the investment decision of an investor.
Now, let's analyze each of the options:
A. This option is incorrect. The Pure Expectations Theory does not suggest that more liquid securities will trade at higher yields than less liquid securities. This is more related to the Liquidity Preference Theory, which states that investors demand a premium for securities with longer maturities, which are considered less liquid.
B. This option is correct. According to the Pure Expectations Theory, an inverse yield curve (where long-term yields are lower than short-term yields) indicates that the market expects interest rates to decrease in the future.
C. This option is incorrect. The Pure Expectations Theory does not explain that yield curves will be normal to compensate investors for price risk. This is more related to the Market Segmentation Theory, which suggests that the shape of the yield curve is determined by supply and demand for securities within different maturity sectors.
D. This option is incorrect. The Pure Expectations Theory does not imply that investors prefer securities with longer terms because there are less transaction costs. This theory assumes that investors are indifferent to the term of the security, as they base their expectations solely on future interest rates.
Similar Questions
At any time, the slope of the yield curve is affected by:Select one:a.inflationary expectations.b.liquidity preferences.c.the comparative equilibrium of supply and demand in the short-term and long-term market segments.d.Both a and c are correct.e.All a, b and c are correct.
Which of the following items will likely not affect the shape of the yield curve?Group of answer choicesMore efficient transaction systems of financial assetsThe market experiencing increasing concerns about the financial health of the economyAn sudden increase in demand for long-term bondsThe market forming a more optimistic outlook of the future of the economy
Which of the following statements is FALSE? A) The shape of the yield curve will be strongly influenced by interest rate expectations. B) We can use the term structure to compute the present and future values of a risk-free cash flow over different investment horizons. C) It is important to use a discount rate that matches both the horizon and the risk of the cash flows. D) The yield curve tends to be inverted as the economy comes out of a recession. E) None of the above is false.
Which of the followings is most likely to be true in describing the relationship between liquidity riskand bond yield relative to the Treasury bond? All else being equal, bonds that are:a) Less liquid have lower yield compared to Treasury bondsb) More liquid have higher yield compared to Treasury bondsc) Less liquid have higher yield compared to Treasury bonds
When a yield curve has a negative slopeGroup of answer choicesthe money market is expecting default by issuers of bank bills.the inflation rate is expected to rise.short-term yields are higher than long-term yields.long-term yields are higher than short-term yields.
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