930 B
930 B
- Expectations Theory (A) — Long-term rates reflect the market's expectation of future short-term rates. An upward sloping curve means the market expects rates to rise. Nothing to do with preference for liquidity.
- Liquidity Preference Theory (C) — Investors prefer short-term bonds because they're more liquid and less price-volatile. They'll only go long-term if paid a premium for the extra risk. This is the one your answer described.
- Market Segmentation Theory (B) — Different institutional players dominate different parts of the yield curve (banks = short-term, insurance companies = long-term). Supply and demand in each segment determines yields. This is the only theory that can explain all yield curve shapes including inverted and humped.
A memory trick:
- Expectations = future rates
- Liquidity = pay me more to go long
- Segmentation = different players, different segments