The market segmentation theory of the term structure of interest rates:
A)assumes that investors will hold long-term maturity assets if there is a sufficient premium to compensate for the uncertainty of the long term
B)assumes that the yield curve reflects the market's current expectations of future short-term interest rates
C)assumes that market rates are determined by supply and demand conditions within fairly distinct time or maturity buckets
D)assumes that both investors and borrowers are willing to shift from one maturity sector to another to take advantage of opportunities arising from changing yields

Question

Quizplus · Accepted Answer

The market segmentation theory of the term structure of interest rates assumes that market rates are determined by supply and demand conditions within fairly distinct time or maturity buckets. This means that investors and borrowers are primarily focused on specific maturity ranges and will only trade within those ranges, leading to segmented markets. This is different from the expectations theory (B), which assumes that the yield curve reflects the market's expectations of future short-term interest rates. The theory of liquidity preference (A) assumes that investors demand a premium for holding long-term assets due to the uncertainty of future interest rates. The theory of arbitrage (D) assumes that investors and borrowers will shift between maturity sectors to take advantage of opportunities arising from changing yields.

The Market Segmentation Theory of the Term Structure of Interest