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FRM Part I · FRM Exam Part I · Properties of Interest Rates

Under the market segmentation theory, which situation best explains a pronounced hump in the yield curve at the 10-year maturity with lower yields at 5 and 30 years?

Market segmentation explains the hump through supply and demand imbalances within separate maturity sectors: heavy 10-year supply relative to demand from investors tied to that maturity pushes its yield up, while strong demand at 5 and 30 years lowers those yields, with no cross-maturity arbitrage.

  1. AInvestors expect rates to rise then fall, and forward rates equal expected spot rates exactly.
  2. BHeavy supply of 10-year bonds relative to demand from investors confined to that maturity, while the 5- and 30-year sectors have strong demand relative to supply.Correct
  3. CA constant term premium that increases linearly with maturity.
  4. DArbitrageurs shifting funds freely across maturities to eliminate any yield differences.

Explanation

Segmentation holds that supply and demand within each maturity sector set yields independently, so a local imbalance at 10 years can create a hump. Options A and C describe expectations and liquidity effects, and D contradicts segmentation because investors do not switch maturities.

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