Financial Markets and Institutions (2-downloads)

1. As we see in Figure 5.4, interest rates on bonds of different maturities move

together over time.

2. When short-term interest rates are low, yield curves are more likely to have

an upward slope; when short-term interest rates are high, yield curves are

more likely to slope downward and be inverted.

3. Yield curves almost always slope upward, as in the Following the Financial

News box.

Three theories have been put forward to explain the term structure of interest

rates—that is, the relationship among interest rates on bonds of different maturi-

ties reflected in yield curve patterns: (1) the expectations theory, (2) the market seg-

mentation theory, and (3) the liquidity premium theory, each of which is described

in the following sections. The expectations theory does a good job of explaining the

first two facts on our list, but not the third. The market segmentation theory can

explain fact 3 but not the other two facts, which are well explained by the expecta-

tions theory. Because each theory explains facts that the other cannot, a natural