Homer Simpson is considering three investment options. Option 1
involves investing in a zero coupon bond for two years. Option 2
involves investing in a five-year zero coupon bond and then selling
that bond in two-year’s time. Option 3 involves investing in a one
year zero coupon bond and then investing in another one year zero
coupon bond when the first zero coupon bond matures. Assume for
this question that three and five year bonds are illiquid at all
times. Which of the following are correct?
i. According to the market segmentation hypothesis, Option 1 would
be preferred to Option 3.
ii. According to the liquidity premium hypothesis, Option 2 is
riskier than Option 1 because the selling price at t=2 could be
very low because three year bonds are illiquid.
iii. According to the pure expectations hypothesis, the actual
return from all three strategies is identical.
iv. According to the preferred habitat theory, Option 1 is
preferred to Option 2 but Option 2 may be preferred if Homer
Simpson believes that the three-year spot rate in two-year’s time
is less than f(2,5)
v. According to the preferred habitat theory, Option 1 is preferred
to Option 3 but Option 3 may be preferred to Option 1 if Homer
Simpson believes that the one-year spot rate in one year’s time is
less than f(1,2).
The correct answer is:
Group of answer choices
(ii) & (iii) & (v)
(i), (ii), (iii) and (iv)
(ii) & (iii)
(i), (ii) and (iv)
(ii) only
Market segmentation means that bond market is segmented i.e they are divided in groups on basis on tenure and yield. As per this Short term interest and lon term interest are independent to each other.
liquidity premium hypothesis means the bonder holder would prefer the instrument i.e bond which is highly liquid. i.e short term bond would be prefer than long term.
pure expectations hypothesis says the the the long term interest and term depends on short term interest.
preferred habitat theory says that invester invest in securities which is beyond the preference of the invester only if some premium is gained. i.e say invester loke short term bonds but would invest in long term only is some risk premium is received.
The correct Answer is :
(i), (ii), (iii) and (iv)
Get Answers For Free
Most questions answered within 1 hours.