Answer each of the 2 essay questions below with a response that is at least 500
ID: 2646583 • Letter: A
Question
Answer each of the 2 essay questions below with a response that is at least 500 words in length. The total submission for this week should be 1000 words in length.
1. Contrast the liquidity premium theory to the market segmentation theory of the term structure of interest rates.
2. Former Congressman Jack Kemp reportedly once said that he wanted to become the most powerful man in Washington, D.C. the chairman of the Board of Governors of the Federal Reserve System. What does Representative Kemp's comment imply about the power of the chairman of the Federal Reserve? Do you think he may have been exaggerating? Explain.
Explanation / Answer
Liquidity premium theory states that an investor will see for a risk premium when investing in a bond or stock which are not readily liquid or are not easilty converted into cash.
In terms of interest rates structure, when liquidity premium is high the interest rates will rise.
As per market segmentation theory, each investor has a set preference for the duration of time he wants to be invested in. Mr X wants to invest in a bond with maturity of 10 years while Mr Y wants to invest in a bond with maturity of 15 years. Their preference for duration is different. Here the interest rates are defined by the additional risk that an investor takes by investing outside his preferred duration.
2. Federal Reserve System is the central bank of USA. Being the central bank, it oversees the regulations of other banks, does economic research, is the lender of last resort etc.
It is a very powerful institution in the domain of finance and its chairman is certainly very powerful.
But it cannot be the most powerful man in Washington D.C. as the most powerful man is the President.