Are these statements correct? Statement 1: The segmented market theory assumes t

Question

Are these statements correct?

Statement 1:      The segmented market theory assumes that bond market participants are limited to purchase maturities that match the timing of their liabilities.

Statement 2:      The preferred habitat theory assumes that bond market participants have a preferred maturity for asset purchases, but may deviate from it if they feel returns in other maturities offer sufficient compensation for leaving their preferred habitat segment.

A.

Both statements are correct.

B.

Both statements are not correct

C.

Only statement 1 is correct.

D.

Only statement 2 is correct.

The spot price of a three year zero coupon bond is 0.8950 and the forward price of a one-year zero-coupon bond beginning in three years is 0.9350. What is the four-year spot rate?

A.

7.21%

B.

6.37%

C.

5.43%

D.

4.55%

A.

Both statements are correct.

B.

Both statements are not correct

C.

Only statement 1 is correct.

D.

Only statement 2 is correct.

Explanation / Answer

1

Option A

2

Option D

Assuming par or face value as 1000

3 year zero coupon price=0.895*1000=895

So, rate for 3 years=(1000/895)^(1/3)-1=3.7669%

forward price for 1 year beginning in 3 years=0.935*1000=935

forward rate for 1 year beginning in 3 years=1000/935-1=6.9519%

So, (1+rate for 4 years)^4=(1+rate for 3 years)^3*(1+forward rate for 1 year beginning in 3 years)

Hence, rate for 4 years=(1.037669^3*1.069519)^(1/4)-1=4.55%

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