Question of the Week – Fixed Income

Thomas Gord, fixed income manager, is discussing the theories of the yield curve and their implications with his colleague. During their discussion, Thomas makes the following statements:

I: “According to the pure expectations theory, rates at longer maturities depend only on expectations of future short-term rates.”
II: “The liquidity preference theory of term structure states that longer term rates reflect investors’ expectations about future short-term rates as well as a liquidity premium.”
III: “The market segmentation theory argues that lenders and borrowers have preferred maturity ranges and the shape of the yield curve is determined by the supply and demand for securities within each maturity range, independent of the yield in other maturity ranges.”

Which of the statements made by Thomas are most likely correct?

• Statement I and II only
• Statement II and III only
• All the three statements are correct