Question

chapter 5

What are the two categories of a dollar return of an investment?

What four factors affect the cost of money?

What is the Liquidity Preference Theory? Do you agree or disagree with the theory?

What is the Market Segmentation Theory? How is it related to short term and long term markets?

Answer 1

There are two categories of return of a dollar return of an investment:

1. Income including interest paid by fixed-income investments,

2. Dividends and capital appreciation representing the change in the   market value of an asset

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The important four factors that affect the cost of money are : Namely

a. Production opportunities,

b. Time preferences for consumption,

c. Risk, and

d. The skill level of the economy's labour force.

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Liquidity Preference Theory is a concept considering interest rate by the supply and demand for money.

As per this concept investor demands a higher interest rate or premium on securities with long-term maturities that carry greater risk because, all other factors being equal, investors prefer cash or other highly liquid holdings.

I fully agree with the theory, as holding period is longer, returns also to be higher.

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Liquidity Preference Theory is a concept considering interest rate by the supply and demand for money.

As per this concept investor demands a higher interest rate or premium on securities with long-term maturities that carry greater risk because, all other factors being equal, investors prefer cash or other highly liquid holdings

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Market segmentation theory is a concept on yield curves on different categories of investments.

Yield curves are determined by supply and demand forces within each market and category of debt security maturities and that the yields for specific category of maturities cannot be used to predict the yields for a different category of maturities.

For short term the yield will be generally lower than that of long term markets as the holding period and can not be compared with each other.

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