Explain (in no more than two paragraphs for each) which of the following stateme

Question

Explain (in no more than two paragraphs for each) which of the following statements are true or false.

A. The traditional liquidity premium theory states that long-term interest rates are greater than the average of current and expected future short-term interest rates

.B. According to the market segmentation theory, short-term investors will not normally switch to intermediate- or long-term investments.

C. According to the liquidity premium theory, investors preferring long-term bonds over short-term bonds would require lower liquidity premium.

Explanation / Answer

A.The statement is TRUE.

Investors prefer to hold short-term securities since they are liquid and can be converted to cash quickly. The liquidity premium theory states that investors will hold long-term maturities only it they are offered at a premium to compensate for the uncertainty of future value. Investors must be offered a liquidity premium to buy long-term securities since they have a high risk of capital loss. Therefore, the long-term interest rates are higher.

B.The statement is TRUE.

Market segmentation theory states that investor have a preference for a specific maturity. Investors are unlikely to switch from one maturity to another without adequate compensation. Investors are likely to prefer short-term bonds over long-term bonds.

C.The statement is FALSE.

Investors prefer short-term bonds over long term bonds since they less interest rate risk. They would prefer long term bonds only if they are paid a risk premium.

I hope that was helpful :)

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